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How Tesco PLC Could Surge 66% In 4 Years

TescoThe shares of top supermarket Tesco (LSE: TSCO), currently trading at 300p, have fallen 27% over the last four years, massively underperforming the 31% gain of the FTSE 100.

But the story could change over the next four years, as Tesco’s shares have the potential to surge 66%.

Here’s how

Tesco’s profit warning following a poor Christmas 2011 has entered the annals of great supermarket shocks. The company had just powered through the recession with the same inimitable annual earnings and dividend growth that had characterised its performance for decades. Few predicted a profit warning was just around the corner — or that three years of declining earnings and a static dividend lay ahead.

The profit warning was all about Tesco’s core UK business. This cash-cow had been over-milked by management to fund international expansion, and needed heavy investment to get back to health.

At the same time, though, international operations were beginning to struggle. Tesco’s attempt to break into the US market with its Fresh & Easy business was written off as losses piled up, while China was also proving a tough nut to crack, and management’s bold go-it-alone strategy was dropped in favour of a local partnership approach.

Tesco’s more established international operations were also suffering. There was cyclical austerity in the group’s East European hub, and local problems in the Asian hub. An altogether perfect storm through which Tesco’s management is now having to navigate.

Analysts are forecasting that earnings-per-share (EPS) declines won’t reach bottom until the year ending February 2016. Their projected recovery thereafter would still leave EPS of 31.1p for 2018 a penny below last year’s 32.1p.

So, how could the shares surge 66% over the period? Well, Tesco is currently so unloved by the market that it trades on a trailing price-to-earnings (P/E) ratio of just 9.3. If, the analysts’ forecasts are right, Tesco will have two years of earnings recovery under its belt by 2018, and sentiment will have changed radically.

A re-rating of the shares to put them in line with the FTSE 100’s long-term average historic P/E of 16 would see the price at 498p — a 66% rise from today’s 300p.

Investors would also bag four years of dividends, although the most bearish analysts do see a cut along the way. Still, consensus forecasts suggest a total of 58p a share paid out over the period. Put another way, a £1,000 investment in Tesco today would deliver £193 in dividends.

Of course, none of this is guaranteed. However, history tells us that a re-rating of an unloved company can deliver super long-term returns for patient investors.

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G A Chester does not own any shares mentioned in this article. The Motley Fool owns shares in Tesco.