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Should I Invest In Tesco PLC Now?

The game is up for Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) and its London-listed peers. The grocery shopping hordes have rumbled the big supermarket chains, stamping a collective foot down to say NO to all the ‘flexible pricing’, shenanigans, smoke, mirrors and tricky dicky cat-and-mouse price-labelling games so beloved of Britain’s largest food purveyors.

Back to value

Up goes the rallying cry: for goodness sake, just put your stuff on the shelves at the lowest price you can in an honest and open manner so that we can trust you and shop with confidence. Don’t try to bamboozle us with two-for-ones and buy-one-get-one-frees, 50%-extra-frees, loss-leading staples and all that old rubbish. We KNOW you’re putting the price up to bring it down, or over-pricing something else we regularly buy to catch us out when you’ve distracted us with your so-called bargains, or putting a similar looking but hyper-priced item right next to a bargain in the hope we’ll pick up the wrong one!

At last, the supermarkets are listening; they have to. Customers are voting with their feet and picking up value-priced food products from Aldi, Lidl, B&M, Poundland, 99p stores and other discounters and the movement is eating into the profits of supermarket chains such as Tesco, whose underlying constant-currency profits came in 7.7% down with the recent full-year results.

Indeed, results season came as something of a shock to the industry, which pitched into a sector-wide price war. However, don’t be fooled by headline grabbing price-axing on staples like bread and milk; just like the bankers, supermarketeers aren’t waking up as totally reformed characters, and there are still plenty of over-priced thumpers in most stores to catch out the unwary shopper, designed no-doubt to claw back the discounts that the ‘difficult market’ has arm-locked the supermarkets in to making.

TescoHow does this leave investors?

Tesco’s first-quarter update shows sales down just about everywhere. As investors, I think we should get used to that kind of thing and adjust our expectations downwards. There’s a good chance that we might be seeing a ‘new normal’ in the sector. I’d like to believe that a sustained customer backlash, manifesting in the rise and rise of the straight-talking discounters, could see the supermarkets dodgy marketing and pricing practices exceed their use-by date.

Perhaps a genuine return to good old-fashioned traditions of quality and value will set in, which could lead to a permanent downwards rebasing in profitability. Investors have always prized supermarket shares for their defensive characteristics. Cash flow is consistent, which leads to steady dividends. However, the flip side is that margins are thin and that makes profits vulnerable. If disruption to the sector is persistent and long-term, which I think it might be, there could be more downside risk than upside potential with Tesco shares. Contrarians should beware. There’s unlikely to be any swift share-price recovery here. Sometimes, it’s right that share prices move down and stay there.

What now?

At a share price of 289p, Tesco’s forward dividend yield is running at 4.9% for year to February 2016, and city analysts expect forward earnings to cover the payout about 1.9 times. Predictions are for an 18% fall in earnings per share this year followed by a 2% recovery the year after.

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Kevin does not own shares in any of the companies mentioned in this article. The Motley Fool owns shares in Tesco.