One of the UK’s best known retail names is Tesco (LSE: TSCO). Millions of Britons shop regularly at the nation’s largest grocery chain. Meanwhile, some investors have Tesco shares in their shopping baskets too.
I see a lot to like about Tesco shares, but at the moment have decided not to buy any. Here, I will explain my logic for that. But first, let me run through some of the positive aspects I see in the investment case.
1. Strong position in a resilient market
Some markets move through good and bad cycles. Luxury goods are one example – when times get tough and consumers tighten their belts, spending thousands of pounds on a handbag can drop down the priority list.
But, no matter what is happening in the economy, people need to eat. Demand in the grocery market is therefore resilient and I see no reason for that to change.
Such a market attracts a lot of businesses. But Tesco’s strong position as the UK market leader means it is well-placed to benefit from long-term consumer demand.
2. Proven business model
Is it hard to do well selling groceries? It may not seem like it at first blush. But consider the number of high street retailers that have shuttered their doors over the years. Think about the brutal price competition from rivals like Aldi and Lidl.
Consider also the impact on already-thin profit margins of increased costs over the past year due to everything from heightened employer National Insurance contributions to product inflation.
Making money as a supermarket chain is harder than it may first seem. Tesco has been in the business for decades and has successfully moved to an operation spanning digital as well as physical sales. It has proven its business model can work well.
3. Tesco stands apart
The company has a number of competitive advantages that I think help set it apart from rivals.
For example, it is not the only supermarket chain to have a loyalty scheme. But Tesco’s Clubcard programme stands apart for its scale. Around four out of every five UK households have at least one Clubcard membership.
The programme has been running for decades and Tesco has developed deep expertise in extracting powerful shopping insights from the data it collects. That has helped it tailor offers to individual shoppers, building loyalty in a targeted way.
The shares look expensive to me
With so much going for the business, why do I have no plans to buy any Tesco shares?
I have already mentioned some of the challenges the company faces, from thin profit margins to intense competition. All companies face risks, so I do not see that as unusual.
But when investing, I want to buy at a price that I think strikes a fair balance between risks and potential reward.
Tesco shares are up 67% over the past five years. They have recently hit their highest price for over a decade.
At the moment, the price-to-earnings ratio is 19. That strikes me as expensive for a mature business in a highly competitive industry with small profit margins.
At a valuation like that, Tesco shares are not attractive for me.
