A cheap FTSE 100 stock I’ll be avoiding in October!

The Tesco share price has picked up some solid momentum since August. Should I consider buying this cut-price FTSE 100 share for my ISA?

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I’m searching for top FTSE 100 bargains to add to my investment portfolio next month. And based on current City forecasts, Tesco (LSE:TSCO) has attracted my attention.

Britain’s biggest grocer trades on a forward price-to-earnings (P/E) ratio of 12.2 times. This sits below the UK blue-chip average of 14 times, and may come as a surprise to new investors.

The supermarket chain is true FTSE 100 royalty, having been one of index’s original constituents when it was founded in 1984. At one point, £1 of every £8 spent in Britain found itself in the company’s tills.

Tesco may be past its heyday as industry competitiveness has increased. But it remains a formidable operator thanks to its exceptional economies of scale. Its successful Clubcard loyalty scheme, meanwhile, has also helped it to retain market share better than say Sainsbury’s or Morrisons. It could retain its dominant position long term.

The trouble is that the budget chains — the rise of which has seen Tesco’s share of the market drop 3% over the past decade, according to Kantar Worldpanel — have much further to grow. This casts a huge shadow over the chain’s investment potential for the next decade and beyond.

Aldi marches on

Fresh trading numbers from Aldi on Monday (25 September) underline the strain established grocers like Tesco are facing.

The German value chain said it attracted 1m more customers in 2022 as the cost-of-living crisis intensified. This pushed pre-tax profit to new record highs of £15.5bn, up £1.9bn year on year.

The chief executive of Aldi UK and Ireland Giles Hurley said:

What we’re seeing is a new generation of savvy shoppers who’ve turned their back on traditional, full-price supermarkets in favour of transparent, low prices.

The value retail sector has been gathering momentum since the 2008 financial crisis. However, the rate at which Aldi and Lidl have been winning shoppers has intensified more recently as inflation has shot through the roof.

Things look set to get even worse for Tesco as these chains rapidly expand. Aldi will have invested £1.4m in the two years to 2024 to build its distribution and shop network, and to improve tech infrastructure and upgrade existing stores. It hopes to add another 500 supermarkets to its portfolio to take the total to 1,500.   

Why I’m avoiding Tesco shares

This ‘race to the bottom’ on prices is having a catastrophic impact on industry profit margins. Aldi’s operating profit margin stood at just 1.2% in 2022. In the 12 months to February 2023, Tesco’s retail margin dropped 54 basis points year on year to 3.8%.

Latest financials showed the company slashing prices on another 700 products (between March and May) to match those offered by Aldi.

Tesco is in a tough place as the importance of value to consumers steadily increases. Until it shows a solid long-term growth strategy this is a FTSE 100 share I’ll continue to avoid.

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.

Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended J Sainsbury Plc and Tesco Plc. 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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