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Retire wealthy: why the Tesco share price could continue to smash the FTSE 100

Supermarket giant Tesco (LSE: TSCO) has been a top performer over the last year, beating the FTSE 100 by a solid 28% or so.

However, the firm’s share price is down by about 7% at the time of writing, following the publication of Tesco’s latest results. Do shareholders need to start worrying, or are big investors simply locking in some gains after a strong run for the firm?

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A well-oiled machine

Tesco grabbed headlines last month when it launched its own discount chain, Jack’s. The move is a bid by chief executive Dave Lewis to keep hold of customers who would otherwise have gone to Aldi or Lidl.

It’s too soon to know whether Jack’s will succeed, but what’s clear from today’s half-year results is that most of the other changes made by Lewis are working well.

Group’s sales rose by 12.8% to £28.3bn during the period, thanks to the integration of wholesaler Booker Group. But this isn’t simply a case of acquisitions flattering growth — like-for-like sales in Tesco UK stores rose by 2.3% during the half year.

Alongside this, Booker like-for-like sales rose by an impressive 14.7%. This suggests to me that the group’s move into wholesale and foodservice (delivering food to restaurants) has been well timed.

What about profit?

Old stock market hands know that turnover is vanity, while profit is sanity. Luckily for shareholders, the group’s profits are also growing strongly. Underlying group operating profit rose by 24% to £933m during the half year, while adjusted earnings rose by 18% to 6.4p per share.

This progress lifted the group’s adjusted operating margin to 2.94%, up from 2.64% for the same period last year. Lewis appears to be making good progress on his promise to increase operating margins to 3.5-4% by the end of February 2020.

One final highlight is that net debt fell by 4% to £3,126m during the six months. This reassures me that Lewis is keeping spending under tight control as he rebuilds Tesco’s profit margins.

Dividend +67%

Tesco may be performing like a growth stock at the moment, but I think most investors would agree that over the long-term it’s likely to be an income play.

Today’s figures certainly included some good news for dividend collectors. The interim dividend will rise by 67% to 1.7p per share, putting the firm on track for a full-year forecast payout of 5.2p per share.

This payout should be covered 2.7 times by forecast earnings of 14.1p per share. This suggests to me that there’s still plenty of room for dividend growth as the group’s recovery continues.

Should you buy today?

Analysts’ forecasts for the year ending 24 February put the stock on a forecast P/E of 15 with a prospective yield of about 2.4%.

Looking further ahead, earnings are expected to climb by another 20% to 17p per share in 2019/20, putting the stock on a P/E of 13, with a dividend yield of 3.2%.

This valuation looks reasonable to me, if not especially cheap. For investors wanting to build a long-term position in Tesco, I think today’s dip could be a buying opportunity.

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Roland Head 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.