Is Tesco PLC Really Worth 180p?

It’s been an interesting year for investors in Tesco (LSE: TSCO). Its share price has been as high as 251p after the market became rather excited about its turnaround plan, but since their April high they have plummeted to 165p within the last month as investors have gradually realised that it will take years, rather than months, to turn the retail giant around.

Clearly, Tesco is in trouble. It has posted disappointing sales figures for a number of years and, in reality, has never been as successful as a business since Sir Terry Leahy left as CEO in 2011 after a fourteen-year stint which saw Tesco transformed from a discount operator to a mainstream, global success. The problem, though, is that Tesco became bloated and started to enter industries where it was ultimately unsuccessful (such as film streaming and used car sales) which drained capital and led to a lack of focus from its management team.

Now, Tesco is doing the exact opposite of the strategy which it pursued with great success in the last few decades. It is attempting to become smaller via the sale of a number of assets, notably its Korean operations, as it seeks to become leaner, more efficient and more profitable. It is also stocking fewer items and a smaller range of products as it seeks to improve its stock turnover and become more efficient.

Furthermore, costs are being cut (for example staff pay rises have been frozen) and Tesco has cancelled the building and opening of tens of superstores which it had planned. It is even likely to end its 24-hour opening at a number of stores because it simply does not make economic sense to open during the night.

The success of all of these changes is yet to be seen. However, the market, as mentioned, became rather excited about them earlier this year, only for investors to once again become nervous regarding Tesco’s future. The truth is that the things Tesco is doing are likely to help its current predicament, but it also needs help from the economy, too.

In fact, the key reason why Tesco has deteriorated in recent years as a business has been the pressure on its customers’ disposable incomes. Since the credit crunch, family budgets have been squeezed as anaemic wage growth plus relatively high levels of food price inflation have caused the likes of Aldi and Lidl to thrive. Such no-frills operators are easily 20%+ cheaper than Tesco and, as a result, shoppers have made the switch.

As ever, though, things always change. Looking ahead, a reversal is taking place: food prices are coming under pressure due to low oil prices and a weak outlook for the global economy, while wages are rising. This means that shoppers are very likely to shop less at Aldi and Lidl and more at Tesco.

This means that Tesco’s performance, versus very weak comparators from last year, is likely to improve. This could stimulate investor sentiment in the stock and easily push it back up to this year’s high of 250p+. And, with a sound strategy, its financial performance could surprise on the upside, but this is likely to take much longer than a few months to complete.

So, while the market remains nervous of Tesco, its strategy, changes in the economy and a price to earnings growth (PEG) ratio of just 0.7 indicate that it is worth a lot more than its current price of 180p per share.

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Peter Stephens owns shares of Tesco. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.