The Tesco (LSE:TSCO) share price has been on a roll recently. Since the start of July, it’s moved up another 6%, reaching a new four-month high. This growth is certainly not as impressive as many of the tech stocks that thrived throughout 2020. But for an established grocery retailer with a 4% dividend yield, that’s not bad. So, what’s causing this recent upward momentum? And should I be considering this business for my income portfolio?
The rising Tesco share price
It seems that there’s renewed interest within the grocery retail market from investors following the latest takeover bids for rival supermarket Morrisons. For a long time, these stocks have been out of favour with the market. And as a result, they have begun to look relatively cheap, in my opinion. Even after the recent rise in the Tesco share price, its price-to-earnings ratio only sits at around 25. That’s a relatively small premium to the historical industry average of 20.
But is the recent rise in valuation justified? After all, if investors are basing their decisions on a potential takeover of Tesco, I think they could be sorely disappointed. Personally, I’m pretty optimistic about the Tesco share price. Not because of a possible takeover, but rather due to the underlying performance of the business.
Looking at the latest set of results, the company published some promising signs of operational improvement. The revenue generated by its supermarkets has increased by nearly 10% compared to pre-pandemic levels. This indicates that the closure of restaurants and bars has pushed many individuals to take up cooking at home, with the habit seemingly sticking even after the hospitality sector reopened. And with increased investment being made in its online infrastructure, maintaining and expanding its market share in the face of increased competition seems likely in my eyes.
Some risks to consider
A notable problem that has plagued the grocery retail sector for years is a significant lack of pricing power. With so many competitors to fend off, Tesco is restricted in how much it can charge for its products. Consequently, its profit margins are exceptionally tight, sitting around 3%. Unfortunately, these margins might be about to get squeezed some more.
With governments issuing stimulus packages around the world to reboot their economies after the pandemic, inflation is on the rise. And for consumers, that means the prices of food and other necessities are increasing. With individuals looking to save money, many may turn to discount retailers like Aldi to buy their groceries. Therefore, to remain competitive, Tesco will likely have to absorb at least part of the cost of rising inflation. Needless to say, that doesn’t bode well for its already strained profit margins. And could start pushing the Tesco share price down.
The bottom line
Despite these risks, groceries remain an essential item for everyone. And the management team’s pursuits to expand and improve its offerings both in and out of its supermarket division could be a driver of steady future growth. Therefore, I would still consider adding Tesco to my income portfolio, even after its recent rise.
