Has Tesco PLC’s Share Price Risen Too Far Too Fast?

After a dismal 2014, Tesco (LSE: TSCO) has got off to a great start this year. The company’s shares have jumped a staggering 22% year to date.

And this performance has pushed Tesco to the top of 2015’s FTSE 100 leader board. Only Randgold Resources has managed to rack up a stronger performance over the past month.  

The demand for Tesco’s shares over the past few weeks has been driven by a strong belief that the company’s turnaround plan will return the group to growth. However, Tesco’s market-leading performance does not mean that the company is out of the woods just yet.

Indeed, the company’s underlying business performance has, based on the limited information available, failed to improve significantly over the past 30 days. 

Optimistic outlook

Tesco has undergone a complete overhaul during the past few months and it’s easy to see why the market is impressed with the company’s actions.

Key to this turnaround has been the replacement of the old management team. New chief executive Dave Lewis was parachuted in and he has not wasted any time implementing much needed reforms. Additionally, a replacement chairman, when finally appointed, should bring more new ideas to the table. 

Dave Lewis has been instrumental in driving Tesco to cut the unwanted fat from the company’s bloated corporate structure. The new CEO has already cut the number of the retailer’s most senior managers by a third and further management changes are planned. 

Furthermore, Tesco’s head office in Cheshunt, Hertfordshire is being closed along with 43 existing stores. A further 49 store developments are also being scrapped and the company is reducing the number of items stocked in stores by a third.  

Overall, the company is hoping to save £250m per annum by making these cuts now rather than later. And there are also plans for Tesco to sell off some of its assets.

Specifically, Tesco has appointed bankers to oversee the sale of Dunnhumby, the retailer’s data analysis arm. Dunnhumby could fetch £1bn to £2bn, helping Tesco to pay off debt and reduce interest costs. 

No evidence yet

But while these plans sound impressive, as of yet there’s little to suggest that Tesco’s turnaround is starting to work. What’s more, it’s unlikely that we’ll know whether or not Tesco’s plan to turn around its fortunes is really starting to work for at least 12 months. These changes need time to filter through the company.

With this in mind, Tesco’s does look to be overvalued at present levels. Indeed, the company currently trades at a forward P/E of 20.7 and earnings per share are expected to fall 65% this year. Growth of just 2% is forecast for 2016 and growth of 23%is expected for 2017. On that basis, Tesco is trading at a 2017 P/E of 16.2, which does seem expensive

So overall, based on Tesco’s current valuation it seems as if the group’s share price has risen too far too fast. What’s more, now the company has slashed its dividend payout, income investors have been left high and dry.

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Rupert Hargreaves owns shares of Tesco. The Motley Fool UK owns shares of Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.