Consumer-facing domestic stocks such as Tesco (LSE: TSCO) have been hurt by the endless Brexit paralysis. Its share price has fallen 7% in a month but this could be your opportunity to nip in and buy at a discounted price.
Brexit isn’t the only reason for the struggles afflicting Tesco stock. As my Foolish colleague Royston Wild recently noted, Morrisons and Sainsbury’s have also had a rough ride lately as German discounters Aldi and Lidl, and online retailers such as Amazon, keep nibbling away.
In some ways I’m surprised Tesco’s market share is still so high. It still boasts a whopping 27.3% market share, way ahead of second-placed Sainsbury’s and Asda at 15.2%. Aldi remains a long way off at 8% but growing fast, with Lidl at 5.8%, according to Kantar WorldPanel.
Tesco CEO Dave Lewis has done well to pursue other growth opportunities, such as the £3.7bn acquisition of wholesaler and convenience retailer Booker, as he should do to justify his massive £4.6m pay packet, which is due to come under scrutiny at Thursday’s AGM. In the accompanying Q1 trading statement I’ll be looking for a progress report on Jack’s, the discount chain he launched to rival the likes of Aldi and Lidl.
In February, Lewis unveiled an impressive 29% hike in pre-tax profits to £1.67bn and an 11.2% rise in revenue to £63.9bn. He declared his turnaround plan would complete in 2019/20, which I thought odd, because I reckon the grocery sector is in a constant state of turnaround, as the big players battle to keep the competition at bay.
I hope ‘Drastic’ Dave isn’t going to start resting on his laurels, although the 9,000 staff at risk in his latest cost-cutting plan may take a different view.
Ironically, Lewis has been helped by inheriting such a mess from predecessor Philip Clarke, including a £250m accounting black hole. Remember that? Or the Hudl, Tesco’s doomed attempt to compete with the iPad and Samsung Galaxy?
He joined from Unilever in 2014 which means he has been there for five years so it could prove ever harder to keep the momentum going.
Growth has been impressive but margins are forecast to drop from a wafer-thin 3.4% to an even more wafery 3.2%. In that context, the return on capital employed (ROCE) of 13% is pretty decent.
The dividend is back after a four-year absence and is forecast to hit 3.2%, with cover of 2.2. It should continue to grow, but only slowly, to 3.9% in 2021. Given the likely Brexit headwinds, Tesco’s shares aren’t as cheap as you might expect, trading at 13.6 times forward earnings.
What slightly baffles me is that City analysts are predicting healthy earnings growth of 21% in the current financial year, and 12% in the next. Where is that coming from? Will British shoppers suddenly get richer? A lot will depend on how we leave the EU on 31 October, assuming we do.
Broker Jefferies recently praised Tesco’s increasingly cash generative nature, and predicted its free cash flow will climb towards £1.8bn by 2021. You might need to keep your nerve if buying this stock, although that’s mostly due to wider economic worries.
Harvey Jones 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.