Why Tesco PLC Offers Ridiculously Poor Value For Money

Quite why investor sentiment towards British grocery giant Tesco (LSE: TSCO) remains quite so giddy continues to puzzle me. Shares have leapt almost 50% since mid-December as an improved sales performance — combined with subsequent decisions concerning store closures and reduced product ranges — has boosted the firm’s appeal.

However, I believe that billionaire investor Warren Buffett’s proclamation last autumn that investing in Tesco had been “a huge mistake,” not to mention subsequent decision to slash his stake in the retailer to less than 3%, is a damning statement of the array of problems the Cheshunt firm faces to get back on a healthy footing.

Sales bounce overshadowed by rivals

I am more than happy to give Tesco credit where it is due, of course, and the stewardship of new chief executive Dave Lewis has coincided with a definite uptick in activity at the checkouts. Indeed, Kantar Worldpanel numbers last month showed sales rise 1.1% in the 12 weeks to March 1, marking the fourth month of improvement and representing a solid uptick from the 3.7% drop posted in November.

Still, Tesco’s top-line rebound has in no small part been thanks to relentless price-shedding, an expensive programme which is clearly unsustainable in the long-term.

And while any return to sales growth is not to be sniffed at, the company’s performance last month pales in comparison with spurts of 19.3% at Aldi and 13.6% punched at Lidl. And Tesco is also struggling to keep affluent customers stepping through its doors, exemplified by Waitrose’s 4.9% advance last month.

Growth drivers under increasing pressure

With Tesco’s network of superstores continuing to underperform, the business is increasingly looking to the online and convenience sub-sectors to deliver meaty earnings growth in the future. But with industry rivals also ramping up their activities in these areas, and German paper Lebensmittel Zeitung reporting that Aldi also planning to enter the UK internet marketplace, I reckon that Tesco may struggle to generate meaningful earnings growth anytime soon.

Consequently I believe that broker expectations of earnings rebounds to the tune of 5% and 33% for the years concluding February 2016 and 2017 are more than just highly fanciful. But even if these projections were to be met, these forecasts still leave Tesco dealing on a P/E multiple of 22.1 times for this year and 17 times prospective earnings for fiscal 2017.

Such numbers are some way ahead of the benchmark of 15 times which represents decent value for money. Indeed, considering that Tesco’s restructuring plan is still at the fledgling stage, and the company still has to prove it can hobble the relentless charge of the competition, I believe that an earnings multiple below the bargain watermark of 10 times would be a fairer reflection of where the embattled supermarket stands at the present time.

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Royston Wild 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.