I have been thinking about the characteristics that might make a share suitable for a place in my pension planning. One option could be for me to invest in Tesco (LSE: TSCO). Here are three reasons I think could potentially make Tesco shares an ideal long-term investment for me – along with some risks I also see.
1. Resilient long-term demand outlook
The first thing I consider when valuing a business is how big the potential market is for it now and in the future. In recent years this has come to be known as a company’s “total addressable market”. That is the market size a firm operates in, both for it and all its potential competitors.
In this regard, I think Tesco looks very attractive. No matter how trends or economic circumstances change the way we live, people will need to eat and drink. I expect robust long-term demand for groceries and the variety of items Tesco sells. That should be good for its future revenues. Last year, its sales were over £1bn a week on average.
2. Strong market position
One risk I see however, is profitability. Big sales do not always equal big profits. Supermarkets have long generated high sales volumes but relatively low profit margins.
The increase in online shopping could make this worse, I reckon. New entrants might see an opportunity to seize market share by discounting, hurting profits for established operators like Tesco.
The economics also look less attractive to me. In bricks and mortar retailing, customers pick and pack goods themselves. In the digital version, by contrast, doing that requires staff or robots – another cost for the retailer.
Set against that though, is the second strength I see in Tesco – its well-established brand. It is the nation’s largest retailer and has a massive customer understanding, thanks to its Clubcard loyalty scheme.
That can help it keep customers and maintain profits in store. But I also think it gives it a competitive advantage online that might help it adjust its digital business model to maintain profitability. That could be good for Tesco shares.
3. Free cash flow potential
I also like the free cash flow potential of a company like Tesco. In its interim results this month, the company reported free cash flow in its retail business of £1.3bn. Over the long term, I expect the business to continue to throw off substantial amounts of excess cash flow that can be used to fund dividends. Currently, the dividend yield is 5.7%.
Why I’m not buying Tesco shares for my pension
That dividend yield certainly tempts me as an investor. But the long-term share price movement at Tesco has been less than compelling, in my view.
When investing for my pension, I have time on my side. So although I like the income potential of Tesco shares, I am less excited by the share price growth prospects – especially if increasing online competition squeezes profit margins.
I do think Tesco could be a good long-term investment for me. But I do not think it is likely to be an ideal one. For those reasons, at least while I see great opportunities elsewhere in the current market, I have no plans to add Tesco to my pension portfolio.
