Why Tesco PLC Could Be A Top Recovery Play

The UK supermarket sector is incredibly competitive. Established players such as Tesco (LSE: TSCO) have seen their market share fall in recent years as discount supermarkets such as Lidl and Aldi have squeezed on one side, while Waitrose and J Sainsbury have captured the higher price point shopper.

Indeed, over the last three years alone, shares in Tesco have fallen by 29% while the FTSE 100 is up over 8%. However, now could be a great time to invest in Tesco – here’s why.

Attractive Valuation

Further problems are, according to Tesco’s share price, already priced in. It currently trades on a price-to-earnings (P/E) ratio of around 10, which is well below the FTSE 100’s P/E of 13.3. This shows that Tesco is not only unloved by the market, but also that investors expect a repeat of the last three years for the business in terms of declining market share and reduced profitability.

TescoHowever, the next three years are unlikely to be the same as the last three and, in fact, Tesco is forecast to increase profits by 4% in 2015. While this is only in-line with the average forecast growth rate of the FTSE 100, it shows that Tesco could begin to mount a recovery over the short to medium term and, furthermore, that its current low valuation may not be entirely justified.

A Great Yield

Although profits have been hit by the aforementioned strong competition, Tesco still offers its shareholders a superb income. Shares currently trade on a yield of 5.1%, which is well above the FTSE 100 yield of 3.5% and is around three times higher than current levels of inflation. Best of all, though, Tesco’s yield is extremely well-covered by profits, with the company paying out less than half of net profit as a dividend. So, even if growth is sluggish, investors should still receive an attractive income from the stock.

A Return To Normality?

Although discount stores such as Aldi and Lidl have performed well in recent years, with the UK economy pulling clear of recession many consumers may switch back to pre-recession spending habits. Certainly, Aldi and Lidl are here to stay, but they have had a significant tailwind in recent years that may not prove to be a feature of a growing economy. As such, Tesco could welcome back shoppers who are still focused on value, but who begin to favour convenience and choice over price.

With a great yield, low valuation and the potential to perform much better than in recent years, Tesco could prove to be a top recovery play over the medium term. 

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Both Peter and The Motley Fool own shares in Tesco.