Tesco (LSE: TSCO) and its market-beating yield have caught my eye today. Though, after some consideration, this isn’t the dividend-paying FTSE 100 share I’d buy today. Let me explain why I’d ignore the retail giant and buy this other blue-chip instead.
Trouble for Tesco
I like Tesco because of its exceptional economies of scale and its market-leading grocery delivery operation. However, I don’t like the FTSE 100 retailer because of its tissue-thin profit margins and the worsening competitive landscape.
For these reasons I won’t buy Tesco, despite its 4.1% forward dividend yield.
The pressure on Tesco’s earnings are growing as costs rise and consumers struggle to make ends meet. Fierce rivals Asda and Morrisons raised the discomfort level further this week too by cutting the average price on scores of essential items by 12% and 13% respectively.
Earlier this month, Tesco projected that annual profits would fall this financial year because of this twin squeeze on margins.
I believe that the threat to Tesco’s earnings stretch well beyond the near term too, as its competitors expand in the real and virtual worlds. And I worry that this could hit shareholder returns hard.
The FTSE 100 dividend stock I’d buy
This is why I’d much rather invest in BAE Systems (LSE: BA) instead. That’s even though its forward dividend yield of 3.6% falls below that of Tesco.
This isn’t just because of its non-cyclical operations (defence spending remains stable during economic upturns and downturns). It’s also not because it has terrific barriers of entry that reduces the threat from competitors (I couldn’t set up a business building submarines in my back garden, for example).
It’s because I expect strong and sustained spending increases on defence products for the foreseeable future. By extension, I think profits and dividends from BAE Systems could expand robustly.
Arms wrestling
The global arms race has been really heating up in recent years as the geopolitical landscape has fractured. And data this week from the Stockholm International Peace Research Institute (SIPRI) shows that such expenditure continues to hit new heights.
Total defence spending worldwide burst through the $2trn mark for the first time ever in 2021, SIPRI said. This was up 0.7% year-on-year in real terms and driven by the US, UK, China, Russia and India.
The war in Ukraine, allied with growing suspicions by the West over Chinese expansionism, mean that spending by the UK and US is likely to keep growing too. This bodes particularly well for BAE Systems as a major supplier of hardware, software and other services to these two nations.
BAE Systems has a great track record of product reliability. One doesn’t become a world-leading defence manufacturer without it. However, the threat of a devastating systems failure — one that could damage the firm’s reputation hard and, by extension, revenues — is one that I can’t afford to ignore.
Still, on the balance things, I think the potential benefits of owning BAE Systems shares outweigh this risk. Unlike Tesco, I’d happily buy this dividend-paying FTSE 100 share today.
