Tesco PLC Is Recovering, But I Still Won’t Be Buying

Tesco PLC (LON:TSCO) will be one of the long-term winners in the retail sector

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Tesco (LSE: TSCO) has come a long, long way since the profit warnings and tumult that led chief executive Philip Clarke to lose his job. Dave Lewis has shown his mettle, and is guiding the retail chain through the current storm.

An impressive recovery

I think you can describe the new strategy in one word: fun. For the first time for what seems like years, I really enjoy shopping at Tesco.

The shops are smarter and more attractive, there are pictures on the wall and the produce is displayed perfectly. After you have done your shopping, you can have a coffee at Harris & Hoole or lunch at Giraffe. When you check through your till receipt, you realise that the produce you bought was as cheap as it has ever been. And when you arrive home, you find that the strawberries you bought are delicious. What’s not to like?

The Tesco of today is doing what it does best: taking care of the details.

And yet, here’s the thing. I still wouldn’t buy shares in Tesco.

Why? Well, I think this is a great company, but it is in the middle of a supermarket sector that is ferociously competitive. With the discounters on the one side, and the premium retailers on the other, it is the customers who hold the whip hand. The sector has too much capacity, and this has meant that profitability has tumbled.

But this story has some way to run

Analyse the numbers and you will see exactly what I mean. At its current price of 213p, the business is on a 2015 P/E ratio of 19. Sounds reasonable? Well, consensus predicts a P/E ratio of 30 in 2016, and 23 in 2017. What’s more, the dividend yield is expected to fall from the current 5.2% to 2.7% and then 1.2%.

Yet the turnover of this retailer has hardly budged. This is clearly a story of over-capacity and rampant competition.

However, as we look to the future, the company can draw on many positives. I think Tesco will be one of the long-term winners in the supermarket sector, because it provides the best overall combination of value, quality and experience. And I think it should not give up on its overseas businesses, because this provides a great opportunity for growth.

But, over the short to medium term, I believe we are still in the midst of a shake-out which has some way left to run. And I think Tesco shares could fall further. Tesco is on my watchlist, but it is still way too early to buy.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Prabhat Sakya 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.

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