The FTSE 100 index is looking vulnerable at these levels, and many investors fear for the worst. On Monday, the index hit a month low below 6,900 and has shown little of a rebound since then. This fall could be due to fears of another Covid-19 winter, which Boris Johnson has mentioned in a statement, or the potential for an energy supply crisis. Either way, the next 12 months looks bumpy, and investors have quickly realised that. For this reason, I am avoiding the index market and looking at buying Tesco (LSE: TSCO) instead due to its weak share price performance this year.
Tesco is a perfect candidate for a rebound with a disappointing 2021, down 12% for the year. Most of the fall happened in February when the share price fell a staggering 25%. Since then, the stock has rebounded strongly, up 15%. Let’s dig into why this crash happened and what to expect going forward.
The February crash
This ‘cliff-like’ drop in February was due to Tesco selling its business in Malaysia and Thailand to CP Group. Selling for £7.6bn, around £5bn of the proceeds went to shareholders as a special dividend, whilst the rest went to the employee pension fund. According to management, this will help simplify and focus the Tesco business. Without this source of revenue to rely on, the Tesco company is now worth a lower amount to an investor, hence the sharp drop in share price.
I agree with management and see the sale as a net positive, allowing the company to focus on its core markets in the UK and the Republic of Ireland, which are particularly strong. This is evident in the two-year sales growth in the UK, which was 9%, while growth in the Republic of Ireland was a high 13%. If Tesco can sustain such high growth rates, it will likely prove to be an excellent investment for me.
Difficulties lie ahead
However, keeping growth rates at a high 9% in the UK will not be an easy feat. 2021 has seen lockdown restrictions ease and the UK moving back to normal, with bars and events opening. This change has likely caused more money to flow into restaurants and less into supermarkets like Tesco. As a result, revenue figures could suffer this year, and the share price performance could be weak.
Furthermore, the shopping sector is becoming extremely competitive. The development of online shopping has caused new competitors to enter the market and take market share from retail giants. One noteworthy company is Ocado, which is expecting “strong revenue growth in FY22”.
Low price competitors, like Lidl and Aldi, have also taken a substantial portion of the market in recent years and are hungry for more.
The dramatic fall in February may seem scary on a stock chart, but digging deeper, it had little to do with business fundamentals. As a long-term investor, if Tesco can fend off fierce competition and develop its online shopping option, it is likely to be a bargain for me at these depressed levels.
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Harry Godfrey has no position in any of the shares mentioned. The Motley Fool UK has recommended 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.