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Why I think the Tesco share price has plenty of room for growth

Under the leadership of chief executive Dave Lewis, the Tesco (LSE: TSCO) performance has vastly improved. The UK’s largest grocer has strengthened its balance sheet, maintained its number one position in the marketplace, recovered from an accounting scandal right at the start of his time as chief executive, and made some pretty smart strategic acquisitions and partnerships.

Therefore, with Mr Lewis set to leave the supermarket, you might question if now is a good time to invest, and that’s understandable. Here’s my answer to that question.

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The opportunity

Although Lewis is widely respected for his turnaround of Tesco I think the hiring of Ken Murphy, coming from Walgreens Boots Alliance, is a smart move. He can take a fresh look at some of the challenges the supermarket faces in terms of improving its operations in central Europe, overcoming Brexit issues, taking on the discounters and adapting to changing consumer shopping habits. He also comes with retail experience. 

Tesco Bank is one area I think Tesco may look to grow. For the year 2018/19 the banking arm made £1.097bn revenue, up 4.7% on the year before. It contributed £167m of operating profit. Having bought in Sir John Kingman, the City grandee who helped shape the government’s response to the 2008 financial crisis, as a non-executive director, I think the bank is an area being prepared for growth.

The bank’s mortgages have been sold to Lloyds Banking Group which also gives it greater opportunity to focus on higher-margin retail banking and insurance services. The competition in mortgages was just too intense for a smaller operation like Tesco Bank to handle. Getting out seems a sensible move. 

Deals in recent years with Carrefour to increase buying power, along with the acquisition of the wholesaler Booker, have consolidated Tesco’s number one status within the UK grocery market. These deals alone have massive potential to help grow the supermarket in the future. More deals that help diversify Tesco away from being just a supermarket would, I think, be beneficial for investors.

The risk

The main potential hurdle is that Lewis could be leaving because he thinks the turnaround is done, little more can be achieved and wants out. An analyst compared his departure to that of Sir Alex Ferguson leaving Manchester United. As with Sir Alex, there could be a risk that the current leader sees change is coming, – most obviously in the form of Brexit – and wants to get out at the top before challenges on the horizon become a problem. 

I’m not sure I agree with that analogy. The succession planning at Tesco is far more robust. Another reason is that although Lewis has done a great job at the supermarket, he was CEO for only around five years. As such, there’s less likely to be a ‘cult of personality’ around him that could hamper the business going forward.

Overall, I believe that the share price could hit five-year highs soon because of the stronger position the grocer is now in. I think the CEO will inherit a much stronger business than Lewis did and will have opportunities to review parts of the business and position the supermarket for further growth that will add value for shareholders.

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Andy Ross 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.