Should I rush to buy Tesco shares today?

Tesco is set to reports its H1 results on Wednesday. John Choong lays out what to expect and whether Tesco shares are worth him buying today.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Britain’s largest retailer is set to report its interim results this week. Tesco (LSE:TSCO) shares have been trading sideways since their Q1 update. So, here’s what investors can expect and whether I should rush to buy the stock before a potential rally.

Points to consider

When Tesco last reported its Q1 trading update in June, the board’s outlook for FY24 remained unchanged. That was for retail adjusted operating profit of £2.6bn, retail free cash flow of £1.4bn to £1.8bn, and Tesco Bank operating profit of £130m-£160m.

This doesn’t come as a surprise as the cost-of-living crisis and lower food inflation act as headwinds to the company’s earnings. Therefore, it’s no surprise to see Tesco shares failing below their May peak of 285p.

Nonetheless, quite a bit has changed since then, and encouraging trends have begun developing. Most prominently, food inflation has come down rather meaningfully. Although this limits Tesco’s revenue growth, this serves to be a net benefit because of a more critical development — real wage growth among its customers. I believe this will be Tesco’s main catalyst in driving its shares up moving forward.

Tesco Shares - UK Food Inflation.
Data source: ONS, Kantar

What to expect

With wages now trending above inflation, there’s naturally been an uptick in disposable income. This should result in three favourable outcomes for the firm.

First of all, fewer shoppers may feel the need to trade down to cheaper supermarkets and lower-margin products. Second, more customers may begin purchasing higher-margin discretionary items once again, thereby growing Tesco’s margins. In fact, CEO Ken Murphy shared on the earnings call that he expects gentle trading up in discretionary products as cost pressures decrease and wages increase.

This thesis isn’t unfounded either. Kantar’s latest grocery reports have seen Tesco outperform its traditional competitors in sales growth. The grocer grew its sales in August and September, by 9.5% and 9.1%, respectively. Meanwhile, budget retailers Aldi and Lidl saw their sales growth slowing (albeit still beating Tesco), dropping to 16.6% in September from 20.5% in August.

I have an optimistic view of the group’s interim earnings and wouldn’t be surprised if Murphy upgrades its outlook for the year. That said, management might opt to maintain guidance to fend off potential ‘profiteering’ claims. Either way, I expect Tesco shares to rise on the back of a robust set of H1 numbers, with an improvement in gross margin due to falling wholesale commodity prices. Those numbers include:

  • UK sales (ex. VAT, ex. fuel) to grow 13% to £22.68bn from £19.99bn
  • Gross margin to improve 170bps to 7.0% from 5.3%
  • Operating profit to drop 2% to £1.29bn from £1.32bn

Should I buy?

Tesco shares may seem overvalued with their price-to-earnings (P/E) multiple of 24.7. However, this is due to impairments relating to property disposals. On an adjusted basis, the stock actually trades at a more reasonable P/E of 12.1.

Given the promising developments and a strong share buyback programme, it’s no wonder analysts at large rate Tesco stock a Buy. I happen to echo the same sentiment as I expect the retail giant to achieve EPS of 23.10p for FY24, giving the stock a forward P/E of 11.4 with a price target of 300p. Of course, I could be wrong, but I’m confident that Tesco shares will generate meaningful returns over the long term. Thus, I’d buy the shares today if I had spare cash.

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.

John Choong has no position in any of the shares mentioned. The Motley Fool UK has recommended 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.

More on Value Shares

Investor looking at stock graph on a tablet with their finger hovering over the Buy button
Investing Articles

Forget Lloyds’ cheap share price! I’d rather consider this FTSE 100 bargain share

Lloyds' share price might appear too cheap to miss at first glance. But this FTSE-listed share could be a better…

Read more »

Silhouette of a bull standing on top of a landscape with the sun setting behind it
Investing Articles

This FTSE 100 stock is down 25% from its 52-week high. Should I buy?

Analysts think the price-to-earnings ratio of this FTSE 100 stock could fall by half in the next two years if…

Read more »

Stack of British pound coins falling on list of share prices
Investing Articles

Here’s why Lloyds shares have dipped sharply

Lloyds shares got a boost recently when the Treasury petitoned the Supreme Court to go easy on the car loan…

Read more »

British flag, Big Ben, Houses of Parliament and British flag composition
Value Shares

The best performing stock in the FTSE 100 over the last 5 years is…

This under-the-radar FTSE stock has surged over the last five years, outperforming the majority of shares in the large-cap index…

Read more »

Investing Articles

What should I buy next in my Stocks and Shares ISA?

A recent sale means Stephen Wright can buy more for his Stocks and Shares ISA. Here are some of the…

Read more »

Investing Articles

£10,000 invested in BAE Systems shares 5 years ago is now worth…

Wars and global tensions have resulted in renewed interest in European defence stocks. Dr James Fox takes a closer look…

Read more »

Investing Articles

UK investors are piling into Vodafone! Should I buy this FTSE 100 stock?

This ultra-cheap FTSE 100 dividend stock has been very popular among retail investors lately. What might they be seeing in…

Read more »

Investing Articles

A £100 weekly income from a Stocks and Shares ISA? It’s possible!

Mark Hartley details how a combination of good stock picks and patience could transform a Stocks and Shares ISA into…

Read more »