Supermarket chain Tesco (LSE: TSCO) delivered its half-year results report on 2 October, trumpeting that its turnaround goals had been “delivered.”
And on the same day, the firm announced that the man brought in to turn Tesco around in 2014, Dave Lewis, will step down as chief executive next year.
A highly competitive market
So, there’s absolutely no doubt about it – the turnaround story at Tesco is over. Now it’s back to everyday business, which I reckon means an ongoing grind to maintain existing market share in a highly competitive market. And that task will fall to the leadership of incoming chief executive Ken Murphy who will start in the post “next summer.” Murphy will be leaving his executive post at Walgreens Boots Alliance to join Tesco.
However, Tesco outlined some of its growth plans in last week’s report and Lewis said that despite “challenging external conditions” the firm had enjoyed a good start to the year. Meanwhile, City analysts following the firm expect growth in earnings to touch about 10% for the trading year to February 2021.
And the agenda looks quite exciting. The firm plans to open 750 Express stores in Thailand and 150 in the UK over the next three years. Four new superstores are planned for the UK and Ireland. There’s an ambition to double online sales in the UK, and three urban fulfilment centres will open by the summer of 2020 with 25 planned over the next three years. The Jack’s brand will also get three more stores by February 2020.
These are gross figures, of course, and don’t account for store closures such as the large, long-established high street Tesco branch that closed its doors for the final time last month in my home town. Indeed, the interim report mentions several times that the firm’s markets are competitive and challenging.
Potential valuation downgrading ahead
Faced with a competitive market, I don’t think it helps any company when its business is low-margin, undifferentiated, and commodity-style in its nature, as Tesco’s is. Economics like that probably caused many of Tesco’s troubles in the first place, leading to the need for Dave Lewis’s help. Indeed, it’s hard for the firm to face down the threat from rivals such as Aldi, which announced plans recently to open more than 100 new stores across the UK in the next two years.
The sector is cutthroat, and as such, I reckon the valuations of individual companies should reflect that fact. But with the Tesco share price close to 236p as I write, the forward-looking earnings multiple is almost 13 for the trading year to February 2021 and the anticipated dividend yield is just below 3.8%. That’s too rich a valuation for my liking. I’d want a dividend yield of at least 5% to compensate for all the ongoing risks of holding the shares.
My guess is that the valuation has yet to fully adjust for the fact that the rapid advances in earnings during the turnaround phase are over. At the current valuation of Tesco, I’d rather collect the dividends from a FTSE 100 tracker fund because the index is yielding a similar amount but without the single-company risk.
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Kevin Godbold has no position in any 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.