Are Tesco shares a bargain at today’s price?

Tesco shares have fallen this year, but the company is weathering current challenges fairly well and offers an attractive yield of almost 5%.

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Tesco (LSE: TSCO) shares have fallen 17% in the last year. They’re cheaper than before but does that make them a bargain?

I was surprised to see that over five years, Tesco shares are actually up 25%. The collapse is quite recent, and we all know why. The cost-of-living crisis has driven up the cost of labour and goods, especially imports due to the weak pound, but supermarkets are struggling to pass the costs onto hard-pressed customers.

Tesco has had wafer-thin operating margins for years. Currently, they stand at 4.2%, but are forecast to narrow to 2.9%. Tesco posted revenues of £61.3bn in 2022 but its pre-tax profit was just £2bn. The UK’s number one grocer works hard for the money.

The shares look cheap

Fighting this year’s consumer squeeze would be tough, but German discounters Aldi and Lidl are making it tougher. Last week, Lidl said it had taken £58m of spending from the big four supermarkets in a single month. Nearly 60% of us shop there and figures from Kantar show Lidl sales soaring 21.5% in a year, with Aldi up 22.7%.

Grocery inflation is now at a record 15% and one in four households are struggling as bills jump £682 in a year.

There is a good reason why Tesco shares trade at just 10.6 times earnings. Last month, it reported a 65% drop in half-year profits to £413m. Management said full-year retail adjusted operating profits would also slip, although they should still come in at between £2.4bn and £2.5bn.

That is surprisingly good, given the circumstances. Tesco also has a solid balance sheet. Net debt looks high at £10.5bn but that’s down from £13.2bn in 2019.

Given that today’s challenging conditions aren’t going to change any time soon, I don’t hold out too much hope of a sustainable rebound in the Tesco share price. The big attraction is the dividend, as the current yield is 4.7%, covered twice by earnings.

Still the one to beat

The payout looks sustainable. Tesco’s retail cash flow grew steadily from £889m in 2019 to £2.28bn in 2022. Last month, management lifted its interim dividend by 20%. It needs to keep investors happy somehow.

Tesco also has scale on its size. It remains by far the UK’s biggest grocer with 27% of the market, streaks ahead of Sainsbury’s at 14.9%, Kantar shows. Aldi and Lidl still have a long way to go, at 9.2% and 7.2% respectively.

Tesco has a loyal customer base and successful Clubcard scheme. Disposing of its operations in Asia and Poland has given the company more focus, although that’s a mixed blessing, given UK woes.

Earnings per share have jumped 89% from 11.58p in 2021 to 21.86p in 2022. I wouldn’t say Tesco shares are a raging bargain right now, given current troubles. However, I think the yield does make them a tempting buy for long-term investors like me.

I’ve bought a few FTSE 100 shares lately and don’t have the money to buy Tesco now. I’ll aim for the January sales. With luck it will be cheaper.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Harvey Jones doesn't hold any of the shares mentioned in this article. 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.

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