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What Tesco PLC’s Investment Plans Mean For Earnings Growth

Today I am looking at why I believe Tesco (LSE: TSCO) remains a high-risk stock selection despite its ambitious expansion plans.

Capex flows at home and abroad

Tesco continues to plough vast sums into turning around its ailing sales fortunes in the UK. Most notably the company is dedicating vast sums into the white-hot areas of online and convenience, and is seeing growth of 13% alone in internet sales.

Not surprisingly Tesco is pulling out all the stops to build on its roaring digital success, from the unveiling of two new ‘dotcom-only’ stores in Crawley and Erith in recent months through to massaging website sales — as well as its other digital services including blinkbox movie and music streaming — via its Hudl tablet PC.

Elsewhere, the company opened 54 Express and 16 One Stop smaller outlets during the first half of fiscal 2014, and the number oftesco such stores are scheduled to continue rolling higher in coming years.

Looking further afield, Tesco’s expansion into foreign shores has resulted in much embarrassment for the Cheshunt-based firm. Most notably the company has been forced to ditch its operations in the US and Japan, and continues to witness a variety of local problems from Europe to Thailand and Korea.

However, Tesco has not thrown in the towel on these potentially high-growth regions, and last month launched a joint venture with Trent Hypermarket — a unit of Tata Group — to establish 12 Star Bazarr and Star Daily supermarkets in India. Tesco has stumped up £85m as part of the deal to gain access to the country’s massive retail sector.

And the move follows the firm’s decision to £345m to merge its 134 stores in the country with China Resources Enterprise’s Vanguard outlets. Rather than reneging completely from entering new territories, Tesco’s realigned strategy for overseas expansion with greater support from local experts under local banners — and with less capital strain — has a better chance of success, in my opinion.

More earnings woe in store

City brokers expect Tesco to print a second heavy double-digit earnings decline for the year concluding February 2014, results for which are due tomorrow (Wednesday, April 16). Earnings are predicted to have dropped 17%, and an additional 6% slide is anticipated for 2015. The supermarket’s turnaround plan is expected to deliver a slight 4% improvement in 2016, however.

Based on these projections, Tesco currently sports a P/E multiple of 10.3 for 2015, and which drops into bargain-benchmark terrain below 10 times forward earnings — at 9.9 — in the following 12-month period.

Still, the supermarket — like the rest of the mid-tier grocery sector — is coming under increasing attack from budget retailers like Lidl and Aldi, as well as high-end chains such as Waitrose. With these firms also planning vast expansion in the near future, Tesco could see earnings continue to struggle for some time to come.

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Royston does not own shares in any of the companies mentioned in this article.