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£2k to invest? I’d buy FTSE 100 defensive dividend growth stock Tesco

Before the accounting scandal broke in 2014, Tesco (LSE: TSCO) was considered to be one of the FTSE 100’s top income stocks. It’s taken the firm five years to recover.

However, it now looks as if the business is on track to earn this title once again. This dividend growth potential, coupled with the firm’s defensive nature, could make it the perfect pick for your portfolio in the current uncertain market environment.

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Dividend growth

When Dave Lewis was parachuted into the CEO role at Tesco, the supermarket giant’s reputation was in tatters. The retailer had been ignoring the needs of its customers for years. On top of this, the accounting scandal had floored its reputation in the City, and a dividend cut had sent income investors running for the hills.

Lewis set out with a plan to turn the business around. He wanted to cut prices, costs and improve efficiency. The then new-CEO set out a 4% operating margin target.

Tesco’s turnaround has now run its course and, as promised, its margins have recovered. This is excellent news for income investors. Net income has jumped from £138m in 2016 to £1.3bn for 2019, allowing Tesco to reinstate its dividend.

The payout was reintroduced at 3p per share in 2018. It was hiked 92% to 5.8p for fiscal 2019 and is set to grow further over the next two years. The City reckons the dividend could hit 9.3p per share in fiscal 2021. This suggests a dividend yield of 3.6% on the current share price.

Special payout

As well as its rising dividend, there’s also a chance Tesco could issue a special dividend when it completes the sale of its large Thai and Malaysian operations. It has been reported three Thai family conglomerates have expressed interest. They could be prepared to offer as much as $10bn, according to the City.

It remains to be seen what Tesco does with this cash, if or when the company does sell. However, analysts are speculating management could either distribute the money with a special dividend or buy back stock.

The funds received would be enough to push earnings per share higher by 10% if used for a buyback, which suggests the stock could rise 10% from current levels if Tesco takes this course of action.

Growth potential

Considering all of the above, the near term outlook for shares in Tesco looks favourable. The company’s long-term prospects are bright as well.

Tesco is unlikely to be unseated from its position as the largest retailer in the country any time soon. What’s more, as the UK’s population and wealth continue to expand, the group’s revenues and profits should only head higher.

As such, now could be an excellent time to snap up Tesco shares if you’re looking for a long-term dividend growth investment. Now that its recovery is complete, it seems there’s nothing that can hold back the retailer’s growth.

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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.