Will Tesco PLC Have A Merry Christmas?

For investors in Tesco (LSE: TSCO), Christmas is not usually a particularly prosperous time of year. That’s because the ailing retailer has failed to post impressive levels of sales or profit growth in recent years, with weak market conditions being the reason cited last year, for example.  

This year, though, the outlook is rather different. Certainly, the supermarket sector is still enduring a very difficult set of trading conditions, but with wages in the UK growing at a faster pace than inflation for the first time in a number of years shopping habits could be different this Christmas than in previous years.

In other words, price-conscious consumers may become more interested in convenience, choice and customer service, with the cost of products arguably less important now that they have more disposable income in real terms. This would benefit Tesco at the expense of no-frills rivals and contribute to improved Christmas trading performance this year for the former.

However, even if Tesco has a disappointing Christmas, the company still has excellent long term potential. For starters, its new strategy appears to be very sound and is focused on generating efficiencies and adding value for customers with regard to improved store layouts, more staff and a more transparent pricing structure.

Furthermore, Tesco is very much becoming a pure play supermarket once again, with non-core activities either being axed or assuming lesser importance when it comes to allocating capital. Since most of Tesco’s sales are from its supermarkets, this move seems to make sense.

Of course, earlier this year the market became rather excited about Tesco’s growth prospects under new CEO Dave Lewis. In fact, the company’s share price increased by as much as 33% by April before there was a realisation that it will take time to turn Tesco around. And, with its bottom line expected to drop by 44% this year, it is clear that the market was overly excited earlier in the year.

Despite this, Tesco’s financial performance in 2016 could act as a positive catalyst on the company’s share price, with it being due to post a rise in earnings of 77%. This puts the company’s shares on a price to earnings growth (PEG) ratio of only 0.2, which indicates that they offer excellent growth potential at a very reasonable price. Furthermore, positive earnings growth would indicate that Tesco may have begun to turn a corner, which could have a very positive impact on investor sentiment.

Clearly, there is a very long way to go in order for Tesco to make a successful comeback. However, profit growth would allow it expand its dividend payments and, with it due to pay out just 19% of profit as a dividend next year, there is plenty of scope to do so.

Certainly, this Christmas could be either ‘hit’ or ‘miss’ for the retailer. But, for long term investors, now seems to be a sound moment to buy ahead of what looks likely to be massively improved performance in 2016 versus weak previous year comparators.

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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.