Shares in Tesco (LSE:TSCO) are up 13% since the start of the year, but the longer-term picture offers a different perspective. Over the last five years, the company’s share price has fallen by almost 20%.
At today’s prices, a 4% dividend yield looks attractive, but a price-to-earnings (P/E) ratio of 25 seems expensive. So is now really the time to buy Tesco shares?
The business
Tesco is one of the best-known companies in the FTSE 100. It’s a supermarket with around 2,800 stores around the UK.
In many ways, the company faces the kind of risks most retailers do. Most notably, with narrow margins, inflation is a constant threat that has been especially significant recently.
There’s also an issue that switching costs for customers are low. It’s much easier for people to change where they shop than it is for them to switch phone providers in the middle of a contract.
The retailer does have some important advantages when it comes to these threats though. First, the company’s size gives it an advantage when it’s negotiating prices with its suppliers.
Second, more than 20m people have a Clubcard. With rewards on offer for members, that’s 20m people who have a reason to shop at Tesco rather than any other supermarket.
The business is relatively simple to understand. But the issue for investors, is what this means for the company’s ability to generate cash going forward.
Outlook
According to a recent study by Kantar, UK grocery shopping has been changing significantly. Some of this is good news for shareholders and some of it is a challenge.
The good news is that in-store discounts are falling, making rewards schemes more important. This is welcome news for Tesco, which already has a well-established membership programme.
The downside is that there seems to be a real shift towards budget retailers. Aldi and Lidl have been growing their sales faster than their more expensive counterparts and taking market share.
Yet it’s worth noting that they haven’t obviously been gaining at the expense of the king on the market. At the moment, Tesco accounts for around 27% of UK grocery, down only 1% from around 28% five years ago.
There’s also another trend going the company’s way. Customers are shifting towards own-label products, which theoretically helps further strengthen Tesco’s hand when it comes to negotiations with branded suppliers. That said, its earlier spat with Heinz of price still ended with it raising prices on Heinz goods.
A stock to buy?
I think Tesco shares look like a fine investment. The rise of budget retailers presents a threat that investors will want to take seriously, but the company has more scope than most to fend this off.
In the short term, inflation is likely to be a challenge and significant growth seems unlikely. But for someone looking for a reasonably predictable source of passive income, this could be a choice worth considering.
