Tesco PLC Is Undervalued By 35%!

TescoTesco (LSE: TSCO) received a fillip on Monday after analysts at Cantor Fitzgerald changed tack and switched straight from a ‘sell’ to a ‘buy’ rating on the stock. The brokerage thinks that Tesco’s core UK business is 35% undervalued compared to its peers, and they have put a 325p price target on the shares.

Reading between the lines, there are two reasons for Cantor’s change of heart.

Turning the corner?

Firstly, it’s calling a halt to the negative momentum dogging Tesco’s share price. An unrelenting stream of bad news has seen the stock lose a fifth of its value over the past 12 months. Cantor has faith that Tesco’s UK turnaround programme will start to work and so reverse its shrinking market share.

But there is a second, significant, strand to Cantor’s thinking. It believes that Tesco will have to shed some of its underperforming hypermarkets. They’re seen by investors as a millstone around the supermarket’s neck — an unfortunate consequence of being market leader. Tesco is the innovator of the sector, and got caught out when out-of-town shopping expeditions fell out of favour with consumers.

Alternative use

Cantor suggests that Tesco will be able to reduce its selling space in hypermarkets without suffering any significant hit. It argues that the company already values much of its land at alternative use value, and that many of its locations would be attractive to housebuilders, leisure companies and higher-margin retailers.

That seems plausible. Organically, Tesco is already reducing selling space with the introduction of family-oriented leisure offerings such as the Giraffe restaurants. There’s no doubting the demand for land for new housing development, albeit that planning permission issues would complicate such a change of use. The popularity of out-of-town leisure complexes shows that a day out in the car en famille hasn’t lost its appeal, even if grocery shopping is no longer the main object.

Alternative management?

Cantor’s analysis is convincing, but my concern is that Tesco’s current management is too stuck in its thinking to carry off radical change. 

I still suspect Tesco’s turnaround will need a change of management, but its dominant market position should see it through. Cantor is early in calling the turnaround in the shares’ fortunes, but wise investors know it’s better to get in too early than too late.

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Tony Reading owns shares in Tesco. The Motley Fool owns shares of Tesco.