Tesco (LSE: TSCO) shares have long been popular with investors seeking out income. It’s easy to see why, as the company has retained its position as the UK’s leading supermarket since the 1990s.
Here, I’m going to take a look at how many Tesco shares I would need to generate £500 a month in passive income.
Well-covered payout
At present, the Tesco dividend yield is 4.37%. This year, it is expected to pay out 10.9p per share.
That means I’d need around 55,000 Tesco shares to generate £6,000 a year — or £500 a month — in passive income. They would set me back approximately £137,500.
Looking forward, analysts expect the firm to pay out 11.9p per share next year. If that dividend forecast proves to be accurate, which isn’t guaranteed, that means I’d receive £6,545 — or £545 a month — from my shares.
While no dividend is certain to be paid, these payouts are expected to be covered nearly two times by earnings. Anything around that mark is generally considered ‘safe’ coverage.
Special dividends
These calculations don’t factor in the potential for special dividends moving forward. These are discretionary payments to shareholders above and beyond ordinary dividends.
The last time Tesco paid one was during the pandemic, after it sold its businesses in Thailand and Malaysia for £8bn. The company used the proceeds from this disposal to reward shareholders with a payment of 50.93p per share.
There could be another (admittedly smaller) special dividend if the retailer sells Tesco Bank. It has been reported that it is considering a sale, which could be worth more than £1bn based on the retail bank’s book value.
Increasing competition
The UK grocery market is notoriously competitive. German discounters Aldi and Lidl have been gaining market share recently as shoppers flock to their stores amid surging food prices.
Meanwhile, online grocer Ocado runs automated warehouses with robots that pick orders at lightening speeds. That could enable it to one day lower grocery prices, potentially stealing market share from Tesco. It may even one day force the supermarket giant to invest billions in its own robotic solutions to compete.
Also, newer rivals such as HelloFresh, the German meal-kit company, offer a totally different proposition. And US tech juggernaut Amazon still has big ambitions to expand in the physical grocery space.
Having said all that, Tesco has faced competition for years and still commands a 27% market share. Many of its customers remain loyal due to its powerful Clubcard loyalty scheme.
Plus, the company has proven adept at rolling out services such as grocery delivery and schemes like Aldi Price Match to ward off competitors.
Not so attractive
The company’s already thin operating margin, which averages around 3.5%, has been under pressure lately after it cut prices on everyday essential items.
However, grocery price inflation has now fallen for four months in a row. If this downward trend continues, that should help shoppers put more items in their baskets.
Still, £137,500 is clearly an awful lot of money to be putting into a single dividend stock — especially one yielding 4.37%. After all, the average one-year fixed Cash ISA rate today is 4.78%.
So I think there are more attractive UK dividend stocks out there for my money right now.
