In December last year, Tesco (LSE:TSCO) shares hit their highest level since 2014. Less than a month on, the stock has struggled to push higher and has actually fallen slightly. Despite the 21% rally over the past year that took the share price to those decade highs, some investors are concluding that the party might be over.
Impact from the economy
One reason being flagged up is the inflection point that we’re at in the UK economy right now. What I mean by this is that over the course of this year, we could head in either direction. We could get a spark to provide a strong year of growth. Or if inflation kicks higher and interest rates don’t drop, we could even head to another recession.
If we get a boom period, Tesco could suffer as consumers decide to ditch the more basic goods and shop for groceries and similar products from higher-end stores. Yet if we get a recession, Tesco shoppers may cut back on what they spend and try and shop around for the best deals. Either way, Tesco revenue could be negatively impacted.
Another point is that in the last three months through to the end of December, Tesco grew supermarket market share to 28.5%. This is the highest since 2016. Even though this is one factor that has fuelled the rally over the past year, it might make some new investors cautious about buying now. Can Tesco really gain more market share in the coming years? Or is it more likely that competitors will start to chip away at this share, causing Tesco to lose ground instead.
Reasons to be positive
On the other hand, there are still reasons to believe that the best days for the business are still ahead. The Q3 and Christmas trading statement was very positive. The 19-week period showed 3.1% sales growth versus the same period last year.
Further, if inflation in the UK remains low and falls back to the target level of 2%, this would further ease the squeeze on profit margins. Tesco is sensitive to inflation due to the impact it has on raw materials. It also operates on small profit margins. So even a modest fall in inflation could spell an increase in profitability for the coming year.
Finally, even though the stock is at such high levels, it’s not massively overvalued. The price-to-earnings ratio sits at 15.5, almost exactly the average figure for the FTSE 100. Therefore, I wouldn’t say it’s cheap but at the same time it’s not flashing red sirens at me based purely on the valuation.
The bottom line
I disagree with the notion that Tesco shares have finished their glory days. It’s true that I won’t be investing right now as I don’t think the stock will rally massively this year. But at the same time I don’t see a major risk that’s going to cause a share price crash.
