If the Morrisons buyout has done one thing, it’s focused investors’ attention on supermarket shares, including Tesco (LSE: TSCO). The Tesco share price has picked up since the middle of June. And Sainsbury has benefited too, following the trend. But after a couple of years of outperforming the FTSE 100, is there still value left for investors today?
Fresh news from Morrisons came on Friday, as the supermarket giant accepted the latest improved offer from Clayton, Dubilier & Rice. The new bid from the US equity group values Morrisons at £7bn. That beats the previously recommended offer of £6.7m from fellow US investor Fortress.
The Morrisons share price has soared 60% since June, so does that suggest Tesco shares are undervalued? Well, I’m not expecting to see a gain anything like that any time soon. And I really don’t think we’ll see an acquisition approach for the UK’s biggest groceries retailer either.
The big jump in the Morrisons share price since the bids started coming in does need to be seen in context. Morrisons had lagged behind the other two over the past two years. So it was arguably on the most attractive valuation in the sector. And with that comes an implication that maybe Tesco is not undervalued after all.
On trailing earnings from February 2021, the current Tesco share price gives us a price-to-earnings of more than 26. It also drops last year’s dividend yield to 3.7%, from 4.1% on year-end prices. That’s bang on the forecast for the FTSE 100 overall, which takes in all the very low dividends too.
Is Tesco overvalued now?
The FTSE 100 is still depressed from the pandemic, and is facing headwinds from the inflationary pressure that’s almost certainly ahead of us. Comparatively, with a significantly higher P/E than the index average, I can see a plausible argument that Tesco has risen into overvalued territory now.
Still, that valuation might slip back should Tesco improve on its earnings this year. The first quarter, to 29 May, was heading in the right direction. Total retail sales rose 8.1% ahead of the same period in 2020. Tesco did also enjoy a 9.3% rise in like-for-like sales, so we’re looking at significant gains from the pre-pandemic period.
But we weren’t out of pandemic restrictions during Q1. And it’s surely going to take a couple of quarters of post-lockdown business before were can get a good handle on Tesco’s underlying trends.
Tesco share price weakness?
Now we’re free to go and shop wherever we choose, some of the impetus behind Tesco online shopping could well tail off. And that, I think, could put pressure on the Tesco share price.
The advantages might be swinging back in favour of Aldi and Lidl. Those two don’t compete with Tesco’s home delivery service. But they still offer cut prices. And though expansion targets will be late being met thanks to Covid, they’ll be getting back on course.
Saying all that, I still rate Tesco as a good long-term dividend investment. I just suspect we could see a little share price weakness in the coming months. It’s one to buy on the dips, perhaps.
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Alan Oscroft has no position in any of the shares mentioned. 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.