At first glance British supermarket colossus Tesco (LSE: TSCO) may be considered as anything but a bona fide growth stock.
After all, the chain has seen its bottom line shrink during each of the past four years as competitive pressures have grown. However, City analysts believe Tesco’s turnaround strategy should set it up for resplendent earnings expansion from this point on.
Indeed, current forecasts suggest a 120% earnings detonation during the period to February 2017, and a further 30% rise in the following year.
And glass-half-full investors would have no doubt been encouraged by Tesco’s blockbuster takeover attempt for Booker Group (LSE: BOK) late last month.
The proposed £3.7bn merger should see Britain’s biggest supermarket bulk up its position in the convenience store market by taking the Londis and Budgens fascias under its wing. Also, Tesco’s move will see it acquire a sprawling cash-and-carry empire.
But it’s Booker’s position as one of the UK’s biggest wholesalers that attracted Tesco to pile in. The business supplies a wide range of fresh and non-perishable foodstuffs to restaurants, pubs and stores the length and breadth of the country.
The supermarket’s chief executive Dave Lewis commented that the deal “will further enhance Tesco’s growth prospects by creating the UK’s leading food business with combined expertise in retail, wholesale, supply chain and digital.”
More earnings woe predicted
But Tesco isn’t the only blue-chip supermarket to undertake potentially-transformative acquisition activity to turn around its ailing fortunes.
J Sainsbury (LSE: SBRY) famously forked out £1.4bn in 2016 to buy catalogue giant Argos, a move designed to create additional revenues streams and reduce the impact of rising competition in its traditional grocery business.
And the takeover appears to be rich with logic. While like-for-like sales at Argos rose 4% during the 15 weeks to January 7, for example, underlying sales for Sainsbury’s traditional operations crept just 0.1% higher.
Despite Sainsbury’s initiative however, ongoing stress in its core operations is expected to keep the bottom line sinking, at least according to analyst forecasts. Drops of 16% and 4% are chalked-in for the years to March 2017 and 2018 respectively.
Not out of the woods
While Tesco’s latest move could prove a stroke of genius, I believe the risks still facing the business aren’t fully factored-in at current share prices. The supermarket changes hands on P/E ratios of 25.9 times for fiscal 2017 and 19.6 times for next year, sailing above the FTSE 100 forward average of 15 times.
Although the proposed Booker Group takeover gives Tesco a strong position in both ‘in home’ and ‘out of home’ segments, the move adds an extra layer of complexity to Tesco’s operating model, and could arguably draw the firm’s eye away from turning around its core retail operations.
Besides, the deal could still theoretically be derailed on competition grounds as the Association of Convenience Stores lobbies the Competition and Markets Authority.
And I retain a particularly bearish stance concerning the long-term outlook for Sainsbury’s, particularly as — unlike Tesco and Morrisons — the London-based operator continues to see sales slipping through the floor.
With no light at the end of the tunnel as yet, I reckon the grocer remains an extremely poor growth pick, in spike of conventionally-cheap P/E ratios of 12.8 times and 13.3 times for this year and next.
Royston Wild has no position in any shares mentioned. 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.