Tesco (LSE: TSCO) has come a long way since the company first uncovered accounting irregularities back in 2014.
Over the past five years, the company has completely remodelled its business, selling off non-core operations around the world and acquiring wholesaler Booker to boost its presence here in the UK.
And even though profits have recovered substantially from the low in 2015 when the company reported a massive loss of just over £5.7bn, the City reckons Tesco’s earnings will continue to rise steadily over the next few years. Analysts are currently expecting the group to report a net profit of just under £1.9bn for its 2021 financial year, up from £1.3bn for fiscal 2019.
Based on these forecasts, I think there is a genuine chance that the Tesco share price could rise back to 300p in the near term.
A robust recovery
Soon after CEO Dave Lewis took the helm, he laid out a set of targets for the company to achieve over the next five years. One of these targets was to achieve an operating profit margin of between 3.5% and 4% for Tesco’s 2019-20 financial year.
Ever since Lewis set out these targets, the City has expressed scepticism that the company will be able to achieve them. However, so far, Tesco has made substantial progress. The group’s operating profit margin for its 2018-19 financial year came in at 2.9%, putting it firmly on track to meet Lewis’s initial goal.
Nevertheless, until the company provides concrete evidence that it has achieved the profitability target, I think the market will continue to doubt its prospects. However, if Tesco does report an operating profit margin of between 3.5% and 4% at the end of its current financial year, then I think this could act as a catalyst for the share price.
Share price catalyst
Since the accounting scandal in 2014, Tesco has been struggling to rebuild its reputation in the city, and meeting the targets laid out by management five years ago would be a huge step towards restoring confidence in the business.
At the same time, if Tesco does achieve its profitability forecasts, the city is expecting management to announce a substantial increase in its annual dividend distributions. Specifically, analysts reckon the company could pay out as much as 8.2p per share for its 2019-20 financial year, giving a dividend yield of 3.5% at the current share price, although I wouldn’t rule out a higher distribution if profits surpass management’s expectations.
The bottom line
So that’s why I think the Tesco share price could return to 300p over the next 12 months. If the company manages to hit its long-term growth target, investor confidence should return, and this will lead to a re-rating of the shares.
What’s more, considering the fact that this is the largest supermarket retailer in the UK, the stock looks undervalued at current prices. It is currently dealing at a forward P/E of 13.7, below the five-year average of around 18. A return to this average would take the stock to about 307p.
Rupert Hargreaves owns no share 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.