The Tesco (LSE: TSCO) share price has delivered worthwhile gains for shareholders since bottoming at the end of 2015. With the stock at 245p as I write, it’s up just more than 60% over four years or so. Shareholders will also have collected a few dividend payments since they restarted during 2018 – that’s not a bad investing outcome for a FTSE 100 recovery play. But what now?
The recovery is over
The first thing I’d note is that the directors think the recovery has run its course. They said so last autumn, and chief executive Dave Lewis is on his way out because the job has been done. Incoming chief executive Ken Murphy will replace him this summer.
Maybe Murphy can lead Tesco to new highs from here. Chairman John Allan described him in the succession announcement as “a seasoned, growth-orientated business leader.” His background included stints with Alliance Unichem and then Boots, where he gained “deep commercial, marketing and brand experience within retail and wholesale businesses.”
But he’ll need every bit of his skills to make Tesco shine in the future, I reckon. Now that the recovery-driven fast rises in earnings appear to be behind the company, everyday growth could be hard to achieve. In the UK, the supermarket sector is fiercely competitive and it looks saturated to me. Maybe Britain just has too many supermarkets, at least in areas of concentrated populations.
With economics like that, there must be severe downward pressure on selling prices. And that’s something supermarkets can ill afford because high-volume turnover and low profit margins have always characterised the supermarket business. Indeed, there’s not much room for error because little changes in the big numbers for revenue and costs can cause big changes in the little numbers for profit.
We’ve seen the way that supermarkets have struggled over the past few years when profits started to slip. But even in such a difficult environment, the likes of Aldi and Lidl have been driving a coach and horses through the market. Their growth numbers are seemingly unstoppable. With a new way of working, they’ve shaken up and disrupted the entire sector.
Headwinds that keep on blowing
And I see the ascendency of this new breed of supermarkets as a massive headwind for the old guard such as Tesco. Indeed, Tesco is continuing its worldwide retreat and the latest move is an announcement in December that it’s evaluating the possible sale of its businesses in Thailand and Malaysia.
Forward-looking growth in earnings has slowed to a single-digit percentage for the current trading year to February and for next year. Meanwhile, a bounce-back of the dividend should put the company on a dividend yield of just under 3.8% for the year to February 2021. That’s not high enough for me. I reckon the stock market is over-valuing the company
The supermarket’s cash-producing credentials and steady dividends used to attract me to the sector. But that was then, and this is now. We’ve seen how supermarkets can let us down, so I’d want a yield north of 5%, at least, to compensate me for the risk of holding the shares today. Even then, I’d think twice with Tesco.
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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.