Although it’s still down 12% over five years, the Tesco (LSE: TSCO) share price has come storming back in 2019 — it’s up more than 30% since the start of the year, while the FTSE 100 has managed a lesser, but still respectable, 10%.
From the brink
Looking at the past few years of earnings progress and peering ahead to forecasts, it’s not hard to see why. From the depths of 2016 when Tesco recorded miserable earnings per share of just 4p, the year to February 2019 brought in 13.6p. And a couple more years of upbeat forecasts would see that rise to around 19p by 2021.
Tesco’s turnaround plan has certainly been working, much to the credit of Dave Lewis, who came aboard in 2014 shortly after the crisis surrounding the company’s overestimation of profits to the tune of £250m that year.
Dividends were reinstated last year with a modest 1.5% yield, and the City is expecting the annual payment to reach 3.9% by 2021. That would be around twice covered by forecast earnings, which is about the same level as sector peers Sainsbury’s and Morrisons.
Forecasts would drop Tesco’s P/E multiple to 12 by 2021, which looks attractive compared to long-term FTSE 100 valuations. But I’m still not buying.
Putting the dividend aside for now, the big question for me is whether the Tesco share price gains can continue through the rest of 2019 and beyond, and I have my doubts. I can see the optimistic expectations for the next few years, and I’m happy to accept that the company has pulled off an impressive turnaround. But I can’t help feeling that those future earnings and dividends are already built into the share price.
And the P/E valuation doesn’t actually look great to me, especially as it’s two years in the future — on expected 2019 earnings we’re looking at a P/E of 16.
Getting back to dividends — I like dividends. In fact, they’re what I look for most in an investment these days. But the 2.3% just announced for the past year doesn’t excite me, and even when I look two years forward to that hoped-for 3.9%, I still don’t see that as tempting. Dividend rises will surely slow once that two-times cover level is reached, and I see many better options out there at a time when the FTSE 100 is offering an overall yield of 4.7%.
I look at the near 6% yields I could have from Royal Dutch Shell or BP, or the 6%+ I’m getting from Aviva, and I ask myself why I would need Tesco?
Dave Lewis has worked wonders, Tesco’s top-heavy bloated business has been massively slimmed, and debts are way down now. From £6.6bn at the end of 2014 (which, ironically, the company at the time said “demonstrates our discipline and focus on cash“), the net debt figure is down to just £2.8bn this year.
But despite all that, which I think marks Tesco’s current management as about the best there is, I just don’t like investing in a highly competitive sector with little or no differentiation between companies. I’ll buy my groceries at Tesco, but my shares elsewhere.
If you’ve ever dreamt of retiring early, or if you’re already retired and protecting your financial independence is your aim, then this could be the report for you!
We at The Motley Fool are pleased to offer you “The Foolish Guide To Financial Independence And Retiring Early” completely free of charge – simply click here to receive these expert insights and strategies.
Alan Oscroft owns shares of Aviva. 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.