Here’s why I bought Tesco shares

The UK supermarket sector is once again in news this week due to the buyout of Morrisons. Royston Roche explains why he bought Tesco shares.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Man shopping in supermarket

Image source: Getty Images.

UK supermarket stocks are in buzz following the recent Morrisons deal. The sector is otherwise considered dull due to the slow growth nature of the mature companies operating in this industry. In contrast, technology companies tend to have robust growth.

I have been closely watching the supermarket sector for the past few months. One main reason was to add a stable large-cap stock from this sector to my portfolio. Here, I will explain why I bought Tesco shares.

The strong fundamentals

Tesco’s fiscal year 2021 revenue grew by 7.1% to £53.4bn. In comparison, its close competitor Sainsbury’s sales fell 0.3% to £32.3bn. The sales were strong as the company was able to increase its market share. Excluding Central Europe and the Tesco bank, sales were even stronger as it grew by 8.8% to £48.8bn. The lockdown was a boon to the company as it grew its UK online sales by 77% to £6.3bn. 

I like companies that have good free cash flows. Tesco had a retail free cash flow of £1.2bn. It has a stable balance sheet. Net debt was £12bn, down 0.3bn from the previous year. The company’s sale of its Asian businesses helped to reduce its pension liabilities by £2.5bn. Its debt-to-equity ratio is 0.59. The ratio is good, in my opinion.

The company’s marketing efforts have been successful in increasing sales. The Clubcard prices, which were launched in September last year, are now extended to over 3,000 products. There are over two million Clubcard app users. Clubcard prices rewarding loyal customers are now available in all 1,844 Express stores. The Aldi Price Match has also helped the company to remain competitive. 

The Tesco shares are trading at a forward price-to-earnings ratio (P/E) of 13, based on analysts’ next year earnings per share estimate of 18.28p. However, actual performance might differ from analysts’ estimates. Currently, Tesco is trading at a P/E ratio of 31.5 compared to the five-year average of 49.78. The shares are trading at a discount to their historical averages. 

Tesco shares – risks to consider

Tesco’s business benefitted from the lockdown as people purchased goods online and grocery item requirements increased as people were at home. Now with the reopening, people will start spending money on restaurants and pubs. Also, there is a high level of uncertainty in the business environment with the rising number of Covid-19 cases. 

The supermarket sector is highly competitive. Consumers can easily compare prices from one store to another. Discount retail stores like Aldi and Lidl are aggressively trying to increase their market share. This could put pressure on the company’s profit margins. 

Conclusion

Tesco is a fundamentally strong company. It is a large-cap stock, which is usually considered more stable. I also like the company’s dividend yield of around 4%. However, I understand that dividends might vary each year, or even be cancelled. In my opinion, consumer demand is strong for the supermarket sector. I am happy to hold Tesco shares in my portfolio, the market leader in the UK grocery sector.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Royston Roche owns shares in Tesco. The Motley Fool UK has recommended Morrisons and Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Middle-aged white man wearing glasses, staring into space over the top of his laptop in a coffee shop
Investing Articles

With a spare £500 I’d buy these UK shares

A financial services giant, a FTSE 250 distributor, a FTSE 100 tech stock, and a gold miner are on the…

Read more »

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

Should I buy this defensive FTSE 100 stock for growth and returns?

This Fool takes a closer look at a FTSE 100 stock to see if it could boost his holdings via…

Read more »

Young female analyst working at her desk in the office
Investing Articles

I robbed Mr Market of this cheap FTSE stock!

This FTSE 250 stock has crashed by almost 30% in six months. But I recently bought into this battered business…

Read more »

Mature people enjoying time together during road trip
Investing Articles

3 reasons I’m backing NIO shares to soar!

NIO shares have bounced up and down this year. But where will the share price go next? My bet is…

Read more »

Portrait of elderly man wearing white denim shirt and glasses looking up with hand on chin. Thoughtful senior entrepreneur, studio shot against grey background.
Investing Articles

Up 300%, is the Hurricane Energy share price an opportunity too good to miss?

This Fool looks at why the Hurricane Energy share price has soared in the past 12 months. Should he buy…

Read more »

Middle-aged white man pulling an aggrieved face while looking at a screen
Investing Articles

The BT share price crashes 20% in a month. Buy now?

The BT share price has crashed by almost a fifth since coming close to £2 on 12 July. After this…

Read more »

A pastel colored growing graph with rising rocket.
Investing Articles

How I’d invest £1,000 in growth shares today to target £5,000 in a decade

Our writer reckons he could do well by choosing the right growth shares today and holding them in his portfolio…

Read more »

Shot of a senior man drinking coffee and looking thoughtfully out of a window
Investing Articles

How passive income from stocks can speed up early retirement

By investing patiently over the years, buying quality shares has given me enough passive income to retire 10 or even…

Read more »