Tesco’s (LSE: TSCO) share price is at a level not consistently seen since January 2011. The latest catalyst for this bullish position was its H1 fiscal-year 2025/26 results, released on 2 October.
The UK’s biggest supermarket group saw sales increase 5.1% year on year to £33.051bn. Over the same period, adjusted operating profit rose 1.6% to £1.674bn.
Free cash flow – a powerful driver for growth in itself – climbed 2.9% to £1.298bn, while net debt fell 3.8% to £9.884bn.
Meanwhile, earnings per share increased 6.8% to 15.43p, and the interim dividend was boosted 12.9% to 4.8p.
A risk to future earnings is any further significant tax rises on businesses or consumers in the upcoming 26 November Budget.
Upgraded forecasts
However, the grocery giant raised its full fiscal-year 2025/26 adjusted operating profit forecast to £2.9bn-£3.1bn, from £2.7bn-£3bn. It continues to anticipate free cash flow within its previous medium-term guidance range of £1.4bn-£1.8bn.
To achieve this, it will continue to build on its four strategic priorities.
The first is optimising value. Examples include its ‘Aldi Price Match’ on 600+ lines, and ‘Low Everyday Prices’ on around 1,000 lines.
The second is enhancing the appeal of its Tesco Clubcard through digital capabilities. This includes a partnership with Pod to collect Clubcard points on EV charging at Tesco stores.
Third, providing more convenient shopping, including opening more stores and increasing home shopping capacity.
And fourth, reducing costs through greater productivity and enhanced business simplification. It is on track to deliver around £500m of its ‘Save to Invest’ target for this year. This will help offset the effects of the last Budget’s increase in employers’ National Insurance contributions.
Given all this, analysts forecast its profits will grow by an average of 9% a year to end fiscal-year 2028/29.
And it is growth in this measure that ultimately drives any firm’s share price and dividends higher over time.
So, how undervalued is the share price?
The discounted cash flow (DCF) model is the best way I have found to ascertain any stock’s true value.
It identifies where any share should be trading, derived from cash flow forecasts for the underlying business.
It also benefits from being a standalone valuation, unaffected by under- or over-valuations of the business sector in which a firm operates.
The DCF for Tesco shows its shares are 30% undervalued at their current £4.46 price.
Therefore, their fair value is £6.37.
My investment view
I prefer to buy stocks that are not just undervalued but that also offer a high yield. This is because I want to reduce my working commitments by optimising dividend income, aged over 50 as I am.
Tesco paid a total dividend this year of 13.7p, giving a current yield of 3.1%. This compares to the present 3.3% average of the FTSE 100 and is below the 7%+ I look for.
Therefore, it is not for me.
However, I believe its strong earnings growth prospects should push its share price to its fair value over time. I also think it will drive its dividend yield higher.
Consequently, I think it is well worth other investors’ attention.
