Tesco (LSE: TSCO) shares have been struggling recently, falling 11% year-to-date. What’s more, they’re down over 6% in the last 30 days. I think this is due to the recent market volatility, which has been caused by rising inflation and interest rates, as well as the Russia-Ukraine situation.
However, I actually think that the UK supermarket chain could be a good hedge against rising inflation. In addition to this, the stock is up over 15% in the past 12 months, with a current healthy dividend of 4.2%. So, should I see this latest share price drop as a chance to open a Tesco position in my portfolio? Let’s take a look.
Reasons to be cheerful
As I mentioned, inflation is rising across the world. In fact, in the UK, the Consumer Price Index rose 7.8% year on year in April 2022. Interest rates are also on the rise in an effort to slow down the UK economy’s growth. While this will likely filter into rising costs for Tesco, I think the retailer could prove a consistent performer as the UK economy slows down. This is because of its ‘defensive’ nature. Being a provider of consumer staples, it will always have demand, regardless of the state of the economy. This should keep cash flow high, and dividend payments consistent.
Another reason I like the look of Tesco shares is the fact the firm has a huge online presence. Since 2020, it has been building its online delivery fleet and in January announced plans to open two more urban fulfillment centers. Analysts at Mintel have predicted that by 2025, the online grocery space could be worth upwards of £22bn. That’s £5bn higher than pre-pandemic levels. An investment in Tesco could be a great way to gain a stake in this growth.
Not out of the woods yet
Both inflation and the cost of living are rising fast. This could lead to Tesco customers switching to cheaper alternatives, such as Lidl and Aldi. Both of these budget supermarkets are rapidly expanding, launching online delivery services that could poach customers from their larger peer due to their competitive pricing. Tesco operates with ultra-thin margins, so needs to remain competitively priced in order to stay profitable.
Its shares currently trade on a 13.2 price to earnings (P/E) ratio. While this isn’t outlandishly high, it’s still above the ‘value’ marker of 10 and under. For context, at their current share prices, competitors Marks and Spencer and J Sainsbury trade on P/E ratios of 10 and 8 respectively. This signals to me that Tesco could be overvalued.
Tesco shares: the verdict
Overall, I think the shares could be a good hedge against inflation and rising interest rates due to their defensive nature. However, I’ll hold back from adding this share to my portfolio, as the P/E ratio looks a little lofty compared to the broader industry. I’m going to wait until the results are released on 17 June before making my move.
