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Why I won’t be adding Tesco plc to my personal portfolio

Over the last 10 years, Tesco (LSE: TSCO) shares have fallen from 460p to 175p, a decline of over 60%. Does that make the UK’s largest supermarket a bargain? In my opinion, no. Here’s several reasons I won’t be adding Tesco shares to my personal portfolio.

Headwinds

The first thing I look for in an investment is a long-term revenue driver. I like big-picture themes such as ageing populations or emerging markets growth – themes that can provide a company with tailwinds in the long term.

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However in Tesco’s case, I struggle to see an attractive theme that will drive revenue growth going forward. While CEO Dave Lewis’s turnaround plan appears to be gaining traction, the supermarket landscape is likely to remain very competitive in my opinion, with discounters Aldi and Lidl continuing to make life tough for Tesco and the other traditional supermarkets. Add in higher wage costs and rising costs from the lower pound, and the environment looks quite challenging to my mind.

Valuation

Furthermore, despite the 60% share price fall over the last decade and the 16% decline year-to-date, Tesco shares still don’t look cheap to me. Indeed, on FY2017 adjusted earnings per share of 6.8p, Tesco’s trailing P/E ratio is a lofty 25.6. FY2018 consensus earnings estimates of 9.9p bring the forward P/E down to a more reasonable 17.6, but this is still far from bargain territory.  

Dividend (lack of)

Tesco’s lack of dividend is another black mark against the investment thesis for me. While Tesco was once a dividend champion, the company took the dramatic step of completely slashing its dividend in FY2015, and hasn’t paid its shareholders a penny over the last two years.

Dividends make up a significant portion of total investment returns over the long term, and for this reason, I prefer to invest in companies that pay me consistent, growing dividends. While Tesco has suggested that it expects to resume dividend payments in 2017/18, consensus dividend estimates of 3.3p per share for FY2018 point to a future yield of just 1.9%, a yield hardly worth getting excited about.

Debt pile

Tesco’s large debt levels also add risk to the investment case. Debt-to-equity stands at 187%, significantly higher than rivals J Sainsbury (38%) and WM Morrison (38%). High debt levels mean large interest payments, and Tesco’s interest coverage ratio is just 2.3, compared to 5.3 and 5.2 for J Sainsbury and WM Morrison. Add in Tesco’s pension deficit, which has ballooned to around £6bn, and we’re looking at company with a significant pile of debt on its balance sheet.  

Downtrend

Lastly, a look at the chart reveals that the share price is trading below both its 50-day exponential moving average (EMA) and its 200-day EMA, suggesting that the stock is trending downwards at present. This indicates to me that the share price may have further to fall and for this reason, I’ll be staying away.

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Edward Sheldon owns shares in J Sainsbury. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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