Shares in Tesco (LSE: TSCO) charged to a 52-week high yesterday after the company unveiled a bumper set of results following years of disappointment. These figures confirmed that Tesco’s recovery is finally starting to get underway and while it’s evident the company does have a long way to go before it has fully recovered from the mistakes of the past, it looks as if investors now believe the worst is behind it.
The big question is, have investors who are looking to buy into Tesco now missed the boat?
Most investors will avoid buying a stock at a 52-week high for fear of buying at the top of the market. However, some academic studies have shown that buying shares at 52-week highs isn’t as damaging to your wealth as you might believe as the research shows that more often than not the shares go on to print new highs.
Still, analysing share price movements is one thing, dissecting the fundamentals is another and when it comes to those fundamentals, Tesco isn’t as healthy as the company’s recent share price movements suggest.
Premium valuation?
At the time of writing shares in Tesco trade at a forward P/E of 26.1, which is in no uncertain terms a premium valuation. That being said, the company’s profits for the first half were curtailed by a number of one-off items. Specifically, pre-tax profits for the six months to the end of August were down 28% at £71m but underlying earnings, excluding one-off items jumped by 60% to £596m.
Barring any unforeseen events, these one-off costs shouldn’t be repeated next year. As a result, City analysts expect the company to earn 9.3p per share for the year ending 28 February 2018. Based on this figure the shares are trading at a 2018 P/E of 19.9. These earnings expectations could be subject to upward revisions in the next few months as yesterday CEO Dave Lewis announced that the grocer is looking to cut an additional £1.5bn from its cost base over the next few years to improve profit margins.
Plenty of work to do
Despite the optimism surrounding Tesco, I believe that group’s shares aren’t worth a high-teens earnings multiple. The business is still in recovery mode, and concerns about the group’s towering debt pile haven’t been addressed by management. Furthermore, yesterday Tesco said that since February its pension deficit has ballooned £3.2bn to £5.9bn due to the collapse in bond yields, which has prompted pension experts to warn that the company’s future dividend payouts may have to take a back seat to pension contributions. Tesco’s total debt is £18bn.
Overall, while there’s some evidence to suggest that buying shares at 52-week highs can be a profitable strategy, it doesn’t look as if shares in Tesco are still attractive on a fundamental basis after recent gains.
