Supermarket giant Tesco (LSE:TSCO) has upgraded its expected annual earnings after strong sales across the Christmas period. The group saw strong sales over the six-week period to 8 January and total sales over the festive period this year grew 3.2% compared to 2020 and 8.8% compared to 2019. As a result, the board expects profits for the financial year to finish slightly above the upper limit of the previous guidance of £2.5bn to £2.6bn. How do I expect this to affect the Tesco share price and should I invest in the grocer today? Let’s explore.
Tesco share price positives
Tesco had a very eventful 2021. Its board made the move to focus on the more lucrative European markets which allowed the company to shed its Asian operations in 2021. This allowed a £5bn special dividend payment and £1.7bn debt reduction last year. The company registered its highest market share in the UK in four years. And this allowed the grocer to ride the economic recovery in 2021. In the first half of 2021, Tesco recorded total sales worth £30.4bn and an operating profit of £1.3bn.
Tesco CEO Ken Murphy addressed concerns in the third quarter (Q3) 2021-22 trading update. “Despite growing cost pressures and supply chain challenges in the industry, we continued to invest to protect availability, doubled down on our commitment to deliver great value and offered our strongest ever festive range”, he said. “As a result, we outperformed the market, growing market share and strengthening our value position”.
Also, Tesco’s new Clubcard rewards means customers can access discounts. Its app has amassed 8.5m Clubcard users and 90% of promotional sales are at discounted prices. And the Tesco Whoosh superfast home delivery program has increased online retail considerably.
But does this make Tesco the biggest FTSE 100 bargain right now? I do not think so. Analysts expect rising inflation rates and raw material costs to eat into grocer profits next year as well. And Tesco’s performance depends on how well it navigates rising competition from discount retailers.
Treacherous 2022?
Inflation is a growing concern in the UK. As we slowly recover from the effects of a two-year lockdown, rising commodity prices are affecting most sectors. For supermarkets, rising labour, transport, fuel, and raw material costs are eating into already razor-thin margins.
Rising costs eventually trickle down to consumers, who are already looking at discount retailers like Aldi and Lidl. Both saw a jump in market share in 2021 which is expected to grow next year as well. Another challenge for Tesco is the rise of Ocado‘s automated warehousing and robotic efficiency with grocery deliveries.
The Tesco share price, at 288p, is trading at a forward price-to-earnings ratio of just 3.3 times. Its dividend yield of 3.17% is covered well by earnings, which is also a positive. The Tesco share price looks cheap on paper, but I think I will wait for its price to drop further before I invest. This is because there are lot of variables that Tesco has to navigate right now. The competition from discounters and rising food costs could impact sales considerably in the coming quarter. The stock is definitely on my watchlist but given the uncertainty surrounding the Omicron variant I am waiting to see how 2022 plays out before considering an investment.
