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Could You Make A Killing Out Of Tesco Plc This Week?

You may not make a huge return by investing in Tesco (LSE: TSCO) this week, but I’d snap up the shares of Britain’s largest grocer ahead of its full-year results on Wednesday regardless, with the aim to fetch a 5-10% pre-tax return by the end of July. Here’s why. 

Managing Expectations

There’s no way around it: Dave Lewis, Tesco’s chief executive, must pull a rabbit out of his hat as soon as possible.

What better an occasion than Wednesday, when annual results are due? 

At 237p, and based on the value of its assets, Tesco currently trades around fair value — in fact, there’s little upside left in the stock right now, I’d argue, unless Mr Lewis surprises the market. The average stock price from brokers currently stands at 245p, with top-end estimates at 325p. 

Tesco has recorded a +42% performance since the multi-year trough it registered in early December, but the stock is essentially flat in the last 12 weeks of trading, and has underperformed the FTSE 100 by almost 4 percentage points.

Quite simply, any upside will be determined by new announcements with regard to disposals and/or big asset write-downs, which would support the investment case. 

Earnings Cycle

At some point, I’d expect property write-downs of up to £2.5bn, which is a reasonable estimate, and may be followed by goodwill write-offs in the region of £300m. 

These are non-cash items that will have a one-off impact on the economic performance of Tesco but won’t alter its cash flow profile. A “clean Tesco” would receive the backing of investors for another quarter or two, at least, with obvious benefits for its stock price. 

I’d expect the shares to rise by 5% or more if management takes the proper steps to fix the balance sheet.

In doing so, it’d also prepare the profit and loss for the next year: Tesco is expected to report just a small economic loss on £1.4bn of trading income on Wednesday — yet the bigger the net economic loss is, the easier will it become in fiscal 2016 to draw the attention of investors with a significant beat to earnings. 

If my estimates are right, the bottom for earnings came in between the second and the third quarter, but Tesco still needs to prove that its accounts are in good order and its pension deficit is under control.

Only then, investors will be able to focus on its operational progress. 

Valuation

As a matter of fact, it’d be easier for a smaller Tesco to deliver value to shareholders.

According to market rumours, Tesco’s Asian assets may command a valuation of about £10bn, which implies a revenue multiple of almost 1x. 

If anybody is willing to pay such a high price, Tesco should get rid of those assets immediately. Its own forward valuation, based on its sales multiple, is less than 0.5 times. 

Other assets are on the action block, and I’d expect material news on Wednesday. 

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Alessandro Pasetti 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.