Tesco PLC Could Be Worth 535p

Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) shares are down 18% over the past 12 months, which is a pretty poor result from the UK’s top groceries seller. And the three-year chart looks even worse, with a 27% fall compared to a gain of 13% for the FTSE 100.

That bad Christmas

TescoIt’s all down to that disastrous Yuletide shopping season at the end of 2011, and though Tesco has been working hard to revamp its business and get the shoppers flocking back, the recovery is taking a fair bit longer than many had hoped — including me, as I added Tesco to the Fool’s Beginners Portfolio in May 2012, since when the share price has been just about flat.

We’ve seen earnings per share (EPS) falls of 16% and 5% over the past two years, and there’s another 15% drop forecast for the year ending February 2015. But after that, analysts are forecasting a return to growth — modest at first, but it’s a start.

Assuming the predicted recovery happens, what’s a Tesco share, currently priced at 296p, likely to be worth in five years time?

Steady cash

For one thing, Tesco has still been paying dividends yielding around 4.5%, which is very good for a supermarket and is comfortably ahead of the FTSE 100’s average of around 3.5%. And what’s more, those payments seem to be adequately covered by earnings.

Extrapolating current forecasts on to February 2019, we could well have a nice cash pot of 73p per share to add to our total return.

So on to the share price. With another little bit of extrapolation, it doesn’t seem unreasonable to predict EPS of 33p per share by February 2019, which would be an improvement on the 26.7p expected for the current year but still short of 2013’s figure.

Assuming a recovery in Tesco’s P/E to around the long-term FTSE average of 14, that would suggest a share price of 462p in five years time. With that 73p in dividends, we’d see a total return of 535p for a gain of 77%. Over the next five years, there will be better gains to be had, but that doesn’t seem at all bad for something as safe as a supermarket.

Bearish outlook

It’s true that the City’s brokers don’t share my mild optimism, with 11 out of 22 urging us to sell Tesco while only four think we should be buying. But the City tends to have a relatively short-term outlook and that bearish stance is likely to be based on their thoughts that there are better places for our money over the next year or two.

I think they’re probably right in that, but I think I’d be on the side of the seven forecasters issuing a Hold recommendation.

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Alan does not own any shares in Tesco. The Motley Fool owns shares in Tesco.