Should I buy Tesco (LSE: TSCO) shares for my portfolio today? That’s the question I’ve been asking myself over the past few weeks.
Now the company has completed the disposal and cash return related to its Asian business, it’s a more focused enterprise. What’s more, after the past 12 months, the organisation has also returned to profitability levels not seen for several years. This is incredibly impressive, considering the general business environment.
The good times might not last. Tesco has benefited over the past 12 months from its designation as an essential retailer. The company has been allowed to keep its doors open while other stores have been forced to close.
There’s also been an impact from the closure of hospitality. As consumers are unable to eat outside of their homes, home cooking is booming. That’s been good news for Tesco, but it won’t continue indefinitely. The latest plans suggest the hospitality industry will be open by the summer. This could lead to a decline in home cooking, especially for speciality ingredients.
As such, I think Tesco shares face a mixed outlook.
On the one hand, the company seems to have put its past problems behind it. Management can now focus on growing the business in its home market. Moreover, some of the cash from the Asian business sale has been used to reduce its debt. This suggests Tesco may be able to return more capital to investors as we advance, rather than using the money to reduce liabilities.
Tesco shares: challenges
But, on the other hand, the group will have to overcome some significant challenges in the medium and long term. These include the demand challenge outlined above and the fact that the UK retail industry is one of the most competitive in the world. Tesco has been fighting the German discount as Aldi and Lidl for years. That’s not going to change. The discounters are still expanding. The retailer is going to have to remain agile to retain customers.
Then there are other changes we don’t yet know about. These could include an increase in the minimum wage, or additional business taxes. Both would hit Tesco’s bottom line as, unlike other companies, the retailer can’t just hike prices to compensate. With Aldi and Lidl snapping at its heels, that may lead to a customer exodus.
Overall, I think Tesco shares look attractive as an investment. The company will face challenges as we advance, but it provides an essential service for consumers. The steady cash flows generated from the predictable grocery business make this a defensive investment, in my opinion.
As such, I’d buy Tesco shares for my portfolio today. Aside from the recent special dividend, the stock could yield as much as 5% per annum going forward, according to current City projections. Of course, these are just projections, and don’t guarantee anything. Nevertheless, I believe they show the stock’s income potential in the best-case scenario.
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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.