The Motley Fool

Is Tesco a ‘buy’ right now?

I last wrote about Tesco (LSE: TSCO) at the end of June and argued then that the turnaround trade in the firm’s shares looked “close to its use-by date.” I said then that the double-digit percentage annual increases in earnings we’ve been seeing looked like a “rebound from a catastrophic earnings collapse.” I thought that progress in rebuilding earnings was being driven by efficiency improvements, and didn’t believe that a sustainable growth story could develop with Tesco because of the threat from discounting competitors such as Aldi, Lidl and others, which are “disrupting the supermarket sector in Britain.”

Plunging share price

But in June, there was a problem with that argument. Despite my bearish stance, the shares were going against me and shooting up, seemingly locked in a strong uptrend. When the article was published, the share price stood close to 257p, but it climbed as high as about 266p during August and then, suddenly, without anyone ringing a bell or blowing a whistle, the shares turned about and started to fall.

And it has been quite a plunge. Today’s 217p or so is more than 18% down from the August peak, and it’s hard to find justification for the fall in the company’s news flow. On 6 August, it announced it had signed off its agreement with French multinational retailer Carrefour Group to form a long-term strategic alliance between the two companies. The move is aimed at improving the quality and choice of products offered to both firms’ customers, as well as driving prices lower to enhance competitiveness. Then there was an interim results report on 3 October, which revealed some good trading figures and a positive outlook.

The Carrefour deal comes hard on the heels of Tesco’s March completion of its takeover of food wholesaler Booker. And in September, Tesco revealed its plans to build up a new discount chain called Jack’s, named after Tesco’s founder, Sir Jack Cohen. The fledgeling chain will be aimed at taking the fight directly to Aldi and Lidl. All these developments sound positive and would surely buoy the spirits of investors hoping for Tesco’s turnaround to continue. But I think such deals show just how far the once-mighty Tesco has fallen, and just how desperate the fight to survive has become.

Back to its roots?

In some ways, it seems rather circular. The Jack’s concept takes Tesco right back to its roots as a ‘pile them high, sell them cheap’ discount grocery retailer. From its origins, the firm grew to become the mightiest supermarket chain in Britain, with tentacles spreading across the globe.

But its lofty ambitions are in retreat. Let’s not forget the collapse of profits and the dividend that signalled the end of Tesco’s period of delivering record earnings. All these new initiatives seem to be aimed at driving selling prices down, and I reckon Tesco’s period of dominance and high earnings came from a policy of driving margins and prices higher, where it could.

I think the shares plunged recently because the valuation got too far ahead. Even now, I wouldn’t buy Tesco shares because I think the firm has too many headwinds. To me, a FTSE 100 tracker fund is far more attractive than taking a chance with Tesco.

Five Income Stocks For Retirement

Our top analysts have highlighted five shares in the FTSE 100 in our special free report "5 Shares To Retire On". To find out the names of the shares and the reasons behind their inclusion, simply click here to view it right away!

Kevin Godbold 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.