The Motley Fool

Why Tesco plc shareholders should cheer £3.7bn Booker Group plc deal

Shares of supermarket giant Tesco (LSE: TSCO) rose by 10% this morning after the group announced a £3.7bn merger deal with wholesaler Booker Group (LSE: BOK). Tesco also confirmed that, as expected, it will restart dividend payments in the 2017/18 financial year.

As a Tesco shareholder myself, I’m pleased with today’s news. But the supermarket’s share price has now risen by 33% in six months. After such strong gains, is Tesco still a buy? Let’s take a closer look.

5G is here – and shares of this ‘sleeping giant’ could be a great way for you to potentially profit!

According to one leading industry firm, the 5G boom could create a global industry worth US$12.3 TRILLION out of thin air…

And if you click here we’ll show you something that could be key to unlocking 5G’s full potential...

What’s on offer?

For each share they hold, Booker shareholders will receive 42.6p in cash and 0.861 new Tesco shares. At Tesco closing price of 189p yesterday, this represents a price of 205.3p per Booker share, or £3.7bn in total.

If Tesco shares hold onto today’s gains, then the deal will be worth more for Booker shareholders. As I write, Booker’s share price is up by 15% to 211p. This represents a 25% gain since Christmas!

This merger should work

Tesco’s turnaround seems to be going well. The group’s Christmas trading statement showed that like-for-like sales rose by 1.5% during the third quarter. But growth is difficult. The UK supermarket sector is very competitive, and is pretty much saturated.

By acquiring Booker, Tesco is gaining access to two new areas of the market. Booker’s wholesale customers are typically restaurants, cafés and takeaways. They include chains such as Carluccios and Wagamama. So Tesco will now be able to sell food to people who are eating out, as well as eating at home.

The second new group of customers for Tesco will be Booker’s convenience store customers. Booker currently supplies about 4,900 convenience stores under the Premier, Londis and Budgens banners. That’s more than double the number of small stores operated by Tesco.

Today’s deal will give Tesco a much bigger share of the convenience store market, assuming the Competition and Markets Authority (CMA) is happy to allow the deal to go through.

Do the numbers add up?

Booker is a well-run profitable company. The group has no debt and reported an adjusted operating margin of 3.8% last year, well above Tesco’s equivalent figure of 2.2%.

Booker’s £5bn annual sales will add about 10% to Tesco’s total revenue. I estimate that this will be enough to offset the dilution caused by the new Tesco shares issued to Booker shareholders. My calculations suggest that the initial effect on Tesco’s earnings per share will be neutral.

The opportunities for Tesco lie in economies of scale and the continued growth of Booker’s businesses. Tesco has already identified about £400m of potential cost savings. The firm believes that more will be possible during the first three years of ownership.

Acquiring Booker should give Tesco what it most needs — an opportunity to deliver growth and higher profit margins.

Is Tesco a buy?

After this morning’s gains, Tesco shares trade on a 2017/18 P/E of about 20. Today’s confirmation that dividend payments will restart means that the stock should yield about 1.8% this year.

That’s not obviously cheap, but Tesco is targeting an operating margin of 3.5-4.0% by 2019/20. If it succeeds, I estimate that earnings per share could reach 20-25p by 2020. On this basis, Tesco could still be good value at current levels.

5G is here – and shares of this ‘sleeping giant’ could be a great way for you to potentially profit!

According to one leading industry firm, the 5G boom could create a global industry worth US $12.3 TRILLION out of thin air…

And if you click here, we’ll show you something that could be key to unlocking 5G’s full potential...

It’s just ONE innovation from a little-known US company that has quietly spent years preparing for this exact moment…

But you need to get in before the crowd catches onto this ‘sleeping giant’.

Click here to learn more.

Roland Head owns shares of Tesco. The Motley Fool UK has recommended Booker. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Our 6 'Best Buys Now' Shares

The renowned analyst team at The Motley Fool UK have named 6 shares that they believe UK investors should consider buying NOW.

So if you’re looking for more stock ideas to try and best position your portfolio today, then it might be a good day for you. Because we're offering a full 33% off your first year of membership to our flagship share-tipping service, backed by our 'no quibbles' 30-day subscription fee refund guarantee.

Simply enter your email address below to discover how you can take advantage of this.

I would like to receive emails from you about product information and offers from The Fool and its business partners. Each of these emails will provide a link to unsubscribe from future emails. More information about how The Fool collects, stores, and handles personal data is available in its Privacy Statement.