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One growth dud I’d sell to buy Tesco plc

Without some sort of economic moat to exploit in a hugely competitive market, it’s only a matter of time before rivals get the upper hand. This, in a nutshell, is why I refuse to have anything to do with online electrical products retailer AO World (LSE: AO).

Since listing back in 2014, shares in the Bolton-based mid-cap had lost almost 70% of their value before today. Based on this morning’s interim numbers, I can’t see sentiment changing anytime soon — such is the fate of those up against the internet leviathan that is Amazon.

First, the good news. Over the six-month period to the end of September, total revenue increased by 13.3% to £368m. Despite a “weaker macro-economic environment“, online sales in the UK rose just under 10% to £282.5m with total revenue here up by 7.4% to £316.8m. In Europe, revenue jumped 60.5% to slightly over 58m, despite “minimal traditional marketing activity“.

But while revenue may be rising, profit certainly isn’t. On this front, AO continues to disappoint. In comparison to the £1.5m generated over the same period in 2016, the company announced an overall adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) loss of £6.3m today. Broken down, UK adjusted EBITDA tumbled 43% to just £7.4m as a result of the necessary evil that is “increased marketing expenditure“. Ongoing investment and “unfavourable” exchange rates also led European losses to increase to the tune of €15.6m.  

With no discernible market advantage, no dividend and an “uncertain macro-economic environment”, finding a reason for a reversal in AO World’s share price as we approach a key trading period for the company is getting more difficult by the day. As such, I’m still to be convinced that the company — describing itself as the destination for consumer electronics for more and more people” — is worthy of investment. It’s a sell for me.

Ready, set, Tesco?

While grocery upstarts Aldi and Lidl continue to nibble away at its market share, Tesco is a far better growth pick in my opinion.

Although rising inflation has led some shoppers to reduce spending on discretionary goods, supermarkets are unlikely to feel the pinch to quite the same extent. Indeed, according to market researcher Kantar Worldpanel, grocery inflation came in at 3.4% in the 12 weeks to November 5. This was the highest level since November 2013 and helped drive supermarket sales growth up by 3.2% year on year, even if the volume of sales hardly budged overall.  

The recent green light from the Competition and Markets Authority (CMA) for its £3.7bn takeover of Booker is another reason to be optimistic about Tesco’s future. Last week’s decision stunned many market participants who assumed that a deal would be dependent on the £15bn giant making some sacrifices. According to the CMA, however, competition in the wholesale and grocery sectors is “sufficiently strong” to ensure that the deal will not lead to higher prices or reduced service. 

Trading at 18 times forecast earnings, Tesco might look expensive for a lumbering FTSE 100 beast but only if you ignore its price-to-earnings growth (PEG) ratio of 0.7 for the current year. Put simply, this means that prospective investors look to be getting a good deal based on an expected jump in earnings. 

Factor-in a resumption of dividend payments and, after a few bleak years, Tesco is finally starting to get its mojo back.

Another top growth pick

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Paul Summers has no position in any of the shares mentioned. 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.