Why I’m confident Tesco shares can provide a reliable income for investors

This FTSE 100 stalwart generated £2bn of surplus cash last year. Roland Head thinks Tesco shares look like a solid choice for dividends.

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Image source: Tesco plc

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As an investor, I’ve noticed that businesses with a leading market share are often good investments. For this reason, I’ve followed Tesco (LSE: TSCO) shares closely, even when the business went through a difficult patch a few years ago.

The UK’s largest supermarket accounts for more than £1 in every £4 spent on groceries in the UK.

Shareholders receive a slice of this spending each year through regular dividends. Tesco paid out £778m of cash to shareholders last year. This amount’s set to increase to around £850m this year, thanks to an 11% dividend increase, announced with the company’s recent results.

The current 12.1p per share payout gives Tesco stock a dividend yield of 4.3%, at the time of writing. To me, this payout looks like one of the safer dividends in the FTSE 100. Indeed, I expect the payout to continue rising over the coming years.

What could go wrong?

Of course, even the best businesses have problems from time to time. Tesco’s been forced to cut its dividend in the past – the payout was actually suspended in 2015 and 2016.

The main risks I can see now relate to regulatory issues. The UK’s Competition and Markets Authority (CMA) is currently taking a look at supermarket loyalty schemes.

Discounted pricing for Tesco’s 21m Clubcard members is one area that’s attracted the regulator’s interest. Sainsbury’s Nectar scheme is also being looked at.

Another possible concern is that the regulator might also take aim at Tesco’s ownership of wholesaler Booker. This allows the retailer to control the stock that’s supplied into thousands of smaller convenience stores, in addition to its own shops.

Why I’m relaxed about these risks

All businesses face risks, all of the time. But for me, these concerns need to be kept in context.

First of all, I think Tesco is being well managed by CEO Ken Murphy. The group’s core retail business generated £2.1bn of surplus cash last year. Debt levels have come down significantly from their peak a few years ago.

My analysis also suggests that Tesco’s profit margins are probably the highest in the UK supermarket sector.

When combined with the group’s market-leading size, I think these qualities mean that this business has a bigger margin of safety than some of its rivals.

If market conditions change, I’m pretty sure Tesco will adapt.

An income stock to consider today?

Grocery shopping is one of the most defensive sectors of the market. Even in a recession, people have to buy food. I would guess that Tesco’s a familiar brand for pretty much every adult in the UK.

If it loses those advantages, I think it’ll be due to management mistakes rather than external pressures. Based on the performance of the business in recent years, I don’t see any sign of this happening soon.

The firm’s shares currently trade on around 11 times 2024/25 forecast earnings. City analysts expect another dividend increase this year, pushing the forecast yield up to 4.5%.

To me, this looks like a fair price for a good business. I reckon Tesco’s likely to continue providing a reliable and growing income for its shareholders.

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.

Roland Head 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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