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Have Tesco shares got their mojo back?

Shares of Tesco (LSE:TSCO), the UK’s biggest supermarket chain, are up more than 25% from last December’s lows at the time of writing, outperforming the FTSE 100, which is up 10% over the same period. Shareholders must be feeling pretty good about that. What has driven this extraordinary growth, and could there be more on the cards?

Good leadership has rebuilt confidence

CEO Dave Lewis has done tremendous work to restore investor faith in the supermarket chain. Taking over in 2014 following an accounting scandal in which Tesco overstated its annual profit by £250 million, Lewis has cleaned up the mess created by the previous administration and made some much-needed changes. In particular, the new regime has cut costs and scaled back some of the supermarket’s more ambitious overseas expansion moves. 

Recent results have been great

Having recently announced preliminary annual results, Tesco reported an annual profit increase of 28%. Same-store sales were up 1.7% for Tesco itself, and up 2.9% overall when factoring in the results from wholesaler Booker, which was acquired in early 2018.

Strong operating results allowed management to increase the dividend to 5.77p/share, up from 3p/share. This prompted Lewis to say: “After four years we have met, or are about to meet, the vast majority of our turnaround goals. I’m very confident that we will complete the journey in 2019/2020”. Moreover, Tesco’s strong cash generation could mean that the company will be able to return more money to shareholders via further dividend increases or stock buybacks.

Competition remains a problem

However, there may be clouds on the horizon. Competition from low-cost retailers like Aldi and Lidl continues to pose a problem. This will become particularly acute if the broader economy takes a turn for the worse. After all, it was during the previous recession that the German discounters were able to massively expand their market share. Currently, they collectively control 13.6% of the UK supermarket market, more than Morrisons, and within striking distance of Sainsbury’s and Asda.

Tesco has had to respond to this threat by cutting prices at its stores, and absorbing that cost by making savings in operating costs and shipping. Despite price cuts, operating margins have risen every year since Lewis took over (1.7% in 2015, 1.8% in 2016, 2.3% in 2017 and 2.9% in 2018).

It hasn’t all been defence, either. In 2018, Tesco launched Jack’s, its own discount store chain. Although this is still in many ways a pilot programme (there are only 9 locations so far), management seems happy with the experiment, and has said that it plans to expand the chain. While Tesco does run the risk of Jack’s siphoning customers away from its main brand, it does seem to at least be better-prepared to deal with the discounter threat than its Big 4 rivals.

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Stepan has no position in any company 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.