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Why the Tesco plc share price is now looking cheap

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It’s three-and-a-half years since Tesco (LSE: TSCO) brought in Dave Lewis as its new chief executive. I remember being mightily impressed by the conduct of the ex-Unilever man at his first conference call and by his vision for turning around the UK’s biggest supermarket chain.

It was always going to be a lengthy process. Not only because of the sheer size of the group, but also because of the number of things that needed fixing and the strategy Lewis came up with to achieve it.

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Retail is detail

There was to be no quick fix. Shareholders would suffer a temporary loss of their dividend but Lewis didn’t ask them to stump up fresh funds in order to throw cash at the group’s problems. He sacrificed its investment grade credit rating and set about his strategy constrained by heavy debt.

He sold assets to lighten the burden. He reversed the sale-and-leaseback strategy (which had boosted past profits but increased future liabilities), re-buying freeholds as and when he could. He sorted out how Tesco dealt with its suppliers. And most important of all, he applied the old adage “retail is detail” to the critical customer-facing side of the business.

Onwards and upwards from 200p

The shares are currently trading at a little over 200p. The fact that they’ve traded at or around this level on a number of occasions since Lewis took charge suggests that the market got a little ahead of itself at these times. While past buyers at 200p have seen no advance, I believe they — as well as new investors today can look forward to a rising share price.

The table below hints at why I believe this. It shows forward 12-month price-to-earnings (P/E) ratios and dividend yields at various dates over the last few years when the share price was in the region of 200p.

Date Share price (p) P/E Dividend yield %
1 July 2015 213 21.6 0.7
1 Apr 2016 190 21.4 0.8
1 Jan 2017 207 21.7 1.0
1 Jan 2018 209 16.5 2.3
22 Feb 2018 205 15.4 2.4

As you can see, the forward P/E at around 200p today is significantly lower than it was at that price in the past. It’s now at a more promising level for the shares to begin rising in line with growing earnings and dividends. What’s more this growth is forecast to be rapid over the next few years, as Tesco’s turnaround continues its momentum and growth is bolstered by its recent deal to acquire wholesaler Booker.

I like this acquisition, as it maintains Tesco’s position as a broadly defensive business, in contrast to Sainsbury’s, whose acquisition of Argos has significantly increased its exposure to discretionary consumer spending. And whether or not Tesco has a secret plan to take on Aldi and Lidl with a new discount chain, I believe Lewis has demonstrated that with the right management, the FTSE 100 giant remains a powerful player, capable of delivering sustainable long-term growth and value for its shareholders.

While buying the shares at around 200p over the past few years hasn’t yet delivered, I reckon they could soon begin to take off and I rate the stock a ‘buy’ at this level today.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended Booker. 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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