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Should I Sell Tesco PLC And Buy Poundland Group PLC?

With just eight days to go until Tesco (LSE: TSCO) is expected to release its full-year results, the stakes are high: Tesco’s share price has risen by 35% since its interim results were published in October.

Sadly, earnings forecasts haven’t risen in the same way, leaving Tesco shares looking decidedly expensive, on a 2015 forecast P/E of 24 and a 2016 forecast P/E of 22.

If the firm’s results contain any hint that Tesco’s turnaround could be slower, or less successful, than expected, the shares could take a bath.

I’ve been looking at possible alternatives to Tesco, including high-street chain Poundland Group (LSE: PLND), where like-for-like sales rose by 2.4% last year, and total sales increased by 11.8%, topping £1bn for the first time.

Is this fast-growing discount retailer a possible long-term income and growth play — like Tesco used to be?

Striking similarities

The first thing I noticed is that there are some surprising similarities between Tesco and Poundland:

 

Tesco

Poundland

2015 forecast P/E

24

25

2016 forecast P/E

22

22

Operating margin

2.3%

2.6%

Both companies are valued on high multiples of forecast earnings, but only one is expected to deliver strong earnings per share (eps) growth this year and in 2016:

 

Tesco

Poundland

2015 forecast eps growth

-65%

+254%

2016 forecast eps growth

+4.2%

+17.5%

This is one of the biggest differences between the two firms: Poundland is growing fast, while Tesco is struggling to reverse falling sales.

Although Poundland’s takeover of 99p Stores may be blocked by the Competition and Markets Authority, which is reviewing the proposed deal, Poundland still opened 60 new stores in the UK and Ireland last year, and is also expanding in Spain.

In contrast, Tesco is shutting 43 stores, and cancelling many planned new stores.

What about dividends?

There’s another difference. Tesco’s reputation as a dividend heavyweight has been destroyed by the firm’s cash flow crunch and flagging sales.

Poundland isn’t exactly a high yield stock, but the discount store’s payout is expected to rise strongly, and looks generous compared to Tesco:

 

Tesco

Poundland

2015 prospective yield

0.6%

1.3%

2016 prospective yield

1.0%

1.5%

The UK’s big supermarkets are having to adjust to a new normal, where profit margins are lower, and sales are shared more widely than in the past.

In contrast, Poundland’s mix of food and general items mean that it is, inevitably, stealing some sales from Tesco, but hasn’t been forced into direct competition with the supermarket giants. Instead, Poundland has profited from the surge in demand for discount retailing.

In my opinion, Poundland’s strategy is smart and well-timed. The group has almost no debt and could well outperform Tesco for a few more years yet.

Despite this, Poundland stock isn't exactly cheap.

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Roland Head 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.