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Tesco is planning to return £5bn to shareholders! Here’s what I’d do now

The Tesco (LSE: TSCO) share price is outperforming the market today after the company revealed that it’s selling its businesses in Thailand and Malaysia.

Asian deal

Following a long strategic review and sale process of its Asian operations, Tesco has agreed on a sale price of $10.6bn on a cash and debt-free basis. After transaction costs, the firm will receive cash proceeds of £8bn. Management is planning to return the bulk of this to shareholders.

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According to today’s announcement, which revealed the details of the transaction, Tesco will return £5bn to shareholders via a special dividend. Based on the firm’s current market capitalisation of £24bn, that suggests a special dividend yield of 20% on the current share price.

The balance will be used to reduced Tesco’s overall debt. Including a £2.5bn contribution to its pension fund. This substantial pension contribution will “eliminate the current funding deficit and significantly reduce the prospect of having to make further pension deficit contributions in the future.

Management expects the deal to complete in the second half of 2020. So far, there’s no guidance on when the special dividend will be paid.

Slimmed-down business

Tesco also said it also plans to double-down on its core UK and European markets when the deal is complete.

The UK division remains the group’s most profitable and valuable business. For the 52 weeks ending 23 February 2019, the Asia Business contributed EBITDA of £640m and operating profit of £265m to Tesco — about 13% of total group operating profit. 

Over the next few years, management wants to capitalise on Tesco’s position as the UK’s largest retailer. It’s planning to invest up to £1.2bn a year in growth opportunities.

These include 25 new fulfilment centres over the next three years to double the company’s online delivery capacity. Management also believes there are “significant growth opportunities” for Booker, the wholesale business Tesco acquired a few years ago.

As well as investing for growth, Tesco is planning to return more cash to shareholders going forward.

Since 2014 the company has been in recovery mode. Now it looks as if management thinks the organisation is ready to move on. The group is targeting a 50% dividend payout ratio going forward (paying out 50% of profits) and is now promising to return any excess cash to investors with share buybacks. This suggests the stock could become a dividend champion over the next few years.

Time to buy Tesco?

Considering all of the above, I think now could be a great time to snap up shares in this retail champion.

Not only will investors receive that hefty special dividend at some point in the next 12 months, but the company’s dividend target suggests its regular dividend is on track to hit 3.5% this year. The stock is trading at a price-to-earnings (P/E) ratio of just 14.

What’s more, Tesco’s business of selling food and other essential products, gives it a defensive nature in uncertain times.

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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.