I used to hold shares in Tesco (LSE: TSCO). Over the years I noticed that the Tesco share price tended to move within a fairly narrow range. Looking at the chart for the past year helps make the point.
The share consolidation last month slightly skews the chart. But looking over most of the past year, Tesco shares show a degree of stability in a period when many stocks gyrated wildly due to the pandemic.
I’m not complaining that the Tesco share price hasn’t crashed. But I wonder: what has been holding it back from bigger rises?
A mature industry under growing pressure
Tesco is a highly experienced retailer. It has the leading share of the UK supermarket sector by some distance. That enables it to foresee customer needs, achieve economies of scale, and manage costs.
In many industries that would make for a profit machine. However, the supermarket business is challenging. As a mature industry, opportunities for growth can be hard to find. But pressures on profitability continue to grow. For example, discount retailers like Aldi and B&M continue to attract customers. That has been very rewarding for B&M shareholders, but makes it harder for Tesco to prosper.
In 2019-20, the retailer’s operating profit margin for the UK and Republic of Ireland was 4.2%. But a decade before, the UK trading profit margin sat at 6%. In percentage points that may sound small – but it’s equivalent to a 30% drop in profitability. That may partly explain the lacklustre Tesco share price performance in recent years, as well as that of some peers.
Digital retail age
Online retail has boomed in the UK. Tesco has worked hard to embrace this possible threat and turn it into an opportunity. In its most recent trading update – for the third quarter and Christmas period – online sales growth exceeded 80%. In its interim results it reported that online sales had grown to 16% of its total UK grocery sales. That makes online an integral part of the company’s business now.
Tesco has also pushed ahead with digital innovation, making the most of its Clubcard data to understand customer behaviour.
So, why hasn’t this led to a share price jump like online supermarket and technology provider Ocado saw last year? I think one reason is that online supermarket sales can damage profitability for a retail chain with a store estate. Decades ago, shoppers picking their own items in store replaced the old system of over-the-counter service. That change occurred precisely because it cut labour costs. Ironically, online sales often require staff not only to pick and pack items, but also to deliver them to customers’ homes. That can cut profitability.
Positive upsides for the Tesco share price
Despite these challenges, I continue to see some possible upside drivers for the Tesco share price.
Its strong position, familiar brand and sophisticated loyalty schemes help to attract and retain customers. The sale of its Asian business allows more focus on the UK and European businesses.
The current yield of around 5% attracts me, though the company did slash its dividend before and could do the same in future.
These don’t strike me as immediate upside drivers for the Tesco share price, though. I would consider Tesco for an income pick, but it wouldn’t make my list of growth shares to buy.
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christopherruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Ocado Group and 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.