Everybody admires a comeback kid, and once-mighty slugger Tesco (LSE: TSCO) has turned out to be quite a scrapper in recent years.
CEO Dave Lewis has worked hard to bring the grocery chain back up to full fitness since his appointment in July 2014, in a bid to beat back the challenge from leaner, meaner rivals Aldi and Lidl. He has had plenty of success. Tesco’s stock is up 29% in the past 12 months, against just 2.3% on the FTSE 100, at time of writing.
However, it’s on the ropes at the moment, down 7% in a month, as Brexit fears tighten their grip, inflation revives, and wages continue to trail. Yet Lewis cannot pin too much blame on retrenching consumers, with British grocery sales growing a healthy 3.8% in the 12 weeks to 9 September, Kantar’s latest figures show, helped by strong demand for ice cream and fizzy drinks in our sweltering summer.
Tesco posted just 1.9% sales growth across the same 12-week period, trailing Asda and Morrisons, which both grew 3.1%. Lidl jumped 8.3%, and Aldi by a frightening 13.9%. The discounters have doubled their market share to 13.1% in the last five years, and still look unstoppable.
Lewis is now taking them on at their own game, launching the group’s new budget chain Jack’s, with the first two stores now open in Chatteris, Cambridgeshire and Immingham, Lincolnshire. Despite the excitement, I cannot see this as a game changer for Tesco.
No frills and spills
Tesco only plans to open between 10 and 15 Jack’s stores in the next six months, so it’s merely testing the water at the moment. By comparison, Aldi and Lidl have more than 700 stores and, as my Foolish colleague Edward Sheldon points out, Aldi is aiming to top 1,000 by 2022.
Lewis is wise to be cautious, given the failure of budget ventures Asda Essentials and Neto from Sainsbury’s. Jack’s is meant to be “no-frills”, but after the early excitement, the move may turn out to be short on thrills, too.
Tesco faces plenty of challenges even if Brexit is settled, or something else remarkable happens, such as wages start to outstrip inflation again. Its stock looks a bit expensive, currently trading at 22.6 times earnings, even if that’s forecast to drop to 16.3 times in the year to 28 February 2019, then 13.8 times.
City analysts are scribbling in a surprisingly bright future, anticipating earnings per share growth of 20% a year over the next couple of years. Revenue forecasts also look promising, with 2018’s £57.5bn expected to hit £65.6bn within two years.
Risk and reward
Tesco’s dividend has some way to go before it can claim comeback kid status. It currently yields just 2.3%, with cover of 2.7, which is expected to hit 3.3% in a couple of years. The company deserves plaudits, but I still think it faces a tough challenge with little room to manoeuvre, as margins remain a wafer-thin 2.7%. That’s a lot of work for relatively little reward.
I share my colleague Royston Wild’s concern that, after a brilliant run, Lewis could struggle to keep landing punches.
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harveyj has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. 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.