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Would You Really Buy Tesco Plc On A P/E Of 22?

Hello fellow Fools, today we’re going to take a look at Tesco  (LSE: TSCO).  I’ll look at what it can do to mend its balance sheet, grow its market share and whether it really is worth a rather punchy price-to-earnings (P/E) ratio of 22.

The Fall From Grace

It won’t be news to regular readers, or to anyone who has watched the news, at how this company — once a stock market darling and global company — lost over half of its market capitalisation, its CEO and CFO and is currently being investigated by the Serious Fraud Office.  Rather unsurprisingly, the share price dropped to a low of 164 pence, a price not seen since January 2000.  Since then, however, the price has recovered to a more respectable 238 pence per share — but is the perceived recovery in the price already?

On The Mend?

Enter ‘Drastic Dave Lewis’ poached from Unilever — he has wasted no time in conducting a thorough strategic review of the business.  The priority seems to be cash conservation. It seems to me that this is the right way to reduce to risk — but at a cost. Alongside other initiatives, the current pension scheme is being closed to all employees, the final dividend scrapped, the disposal of the broadband and Blinkbox business to TalkTalk and the current head office is being closed.  

Despite this, year-end net debt is expected to be almost £9 billion. That is almost half of its current market capitalisation.  I think that there is plenty of work that needs to be done to reduce this further.  Despite all of this bad news and cost cutting, the Christmas trading update in January noted a slowing in the downward trend and Europe returned to growth, albeit only by 1%. This has helped to propel the shares to where they sit today.

A Bit Too Rich For My Blood

In my view, as an investor, there is a lot to like about the plan going forward.  Indeed, we have a leading brand with a huge market share — I would not write these shares off as junk.  However, with a price to earnings ratio of 22 times this year’s expected earnings and a huge debt pile that needs to be addressed sooner rather than later and no dividend to speak of, I wouldn’t even consider the shares as a long-term investment at these prices. I’d be looking for a price closer to 120-130 pence to tempt me in.

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Dave Sullivan has no position in any shares mentioned. 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.