Right now, Tesco’s (LSE:TSCO) share price appears to offer attractive all-round value to investors. At 224p per share, the FTSE 100 supermarket trades on a forward price-to-earnings (P/E) ratio of 10.7 times.
This roughly matches industry rival Sainsbury’s whose market share is steadily eroding. It’s also lower than the FTSE index average of around 11.5 times.
Tesco shares also appear particularly attractive on an income basis. Dividend yields sit at 4.7% and 4.8% for the financial years to February 2023 and 2024 respectively.
Both readings are around a full percentage point higher than the FTSE 100 average. So are Tesco shares a no-brainer buy for value investors?
A brilliant bargain?
I’ll begin by declaring that the supermarket’s profits aren’t tipped to grow over the short term. City analysts expect Tesco’s earnings to fall 4% this year before stabilising in fiscal 2024.
These are hardly the sort of projections to get investors excited. But some might argue that the company’s leading position in a defensive sector mean its shares demand a premium in today’s climate.
Spending on food and household goods remains broadly stable at all points of the economic cycle. So revenue estimates for the short-to-medium term could be considered pretty robust, certainly compared with those of many other FTSE 100 stocks.
Tesco’s UK like-for-like sales rose 0.7% between March and August, even as the cost-of-living crisis accelerated.
But there are other reasons why the business could be considered cheap. And especially when stacked up against industry rivals like J Sainsbury.
Tesco has the biggest and most popular online operation of all Britain’s major supermarkets. And profits here could be set to boom as e-commerce in food retail takes off. Research suggests the online grocery market will expand at a compound annual growth rate of 25.3% through to 2030.
Furthermore, the company’s Clubcard loyalty card scheme is a powerful weapon to help it defend its market share. The steady flow of vouchers customers get through the post also encourage them to keep coming back.
Margin risks
Having said that, Clubcard on its own doesn’t protect the FTSE 100 firm completely from competitive pressures. In fact, the Tesco’s long-term outlook is clouded by the expansion programmes of rival supermarkets, and in particular the new store rollouts of Aldi and Lidl.
The German discounters offer products of comparable quality to the established grocers. They do it at a cheaper price too. This is a big problem for established chains who are frantically slashing prices to compete.
The trouble this is causing for Tesco’s margins are particularly severe today as it also battles higher costs. Margins at its core UK and Ireland retail operation slumped 0.8% between March and August to just 3.9%.
Energy and food costs also look set to remain elevated, while a tight labour market means higher staff wages.
The verdict
On paper, Tesco’s share price looks cheap. But in reality, I think the grocer’s low valuation reflects its crushing margin pressures that look set to keep climbing. There are other cheap FTSE 100 shares I’d much rather buy for 2023.
