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Should I buy or avoid Tesco shares?

Image: Tesco

I think Tesco (LSE: TSCO) shares are a defensive investment. This means the stock tends to be uncorrelated to downturns in the economy. Even during downturns, people need to buy groceries, though they may cut back on their spending.

I’d buy Tesco shares in my portfolio and here are the reasons why.

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Mature market

Supermarket chain Tesco operates in a mature market. This means that the pace of growth is likely to be slow. I’m not worried about this because Tesco has a dominant share in its sector.

That doesn’t mean the company should get complacent. It needs to find innovative ways to continue to grow and retain customers. Over the past five years, Tesco has been trying to turn its business around.

In 2016, it set out a strategy to stabilise the business, build the brand, and move towards growth. But this is easier said than done, especially when it’s operating in a mature market. In fact, 2019–20 marked the end of the turnaround and it held a Capital Markets day in June 2019 to share the untapped value opportunities it would focus on.

Untapped opportunities

Tesco is focusing on growth through opening new Express format stores. These are smaller shops that typically have less choice than their larger counterparts. I think this enables Tesco to boost its brand and distribution network at lower cost.

I like that the supermarket chain is also focusing on customer service and rewarding loyalty. At the end of 2019, it launched the UK’s first grocery loyalty subscription service, Clubcard Plus, giving customers even more value from their shop, including 10% off two big shops in-store each month. The main thing here is that Tesco can use the data from its large customer database.

It’s pleasing to see that Tesco even intends to capitalise on the growing trend of veganism and flexitarian diets. It has launched its own plant-based range, which it will continue to expand.

Tesco is also using technology to make the customer experience seamless. In fact, from its third-quarter results, online sales have grown strongly. But the coronavirus crisis has acted as a catalyst here.

Disposals

In my opinion, the cost of Tesco’s attempt to expand internationally was losing focus on its core UK business. In order to simplify, the company has been disposing of its international operations. It completed the £8.2bn sale of its businesses in Thailand and Malaysia in December.

I think it is encouraging that management is shareholder-friendly. This is a quality that I like to see from board members. From the sale proceeds, Tesco has distributed £5bn as a special dividend and paid a one-off contribution of £2.5bn to its pension scheme.

Competition

While I’d buy Tesco shares, the business does face stiff competition. Aldi and Lidl are giving the supermarket chain a run for its money. Even the partnership between Amazon and Morrisons poses a threat to Tesco.

But Tesco has recognised this and last year launched Aldi Price Match, to provide competitive prices. I’ll certainly be watching out for Tesco’s full-year results next week on 14 April.

As an income hungry investor, I like that Tesco shares offer an attractive dividend yield. It has a large chunk of the UK grocery market and operates in a defensive sector. Everyone has to eat. For now I’d buy the stock.

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Nadia Yaqub has no position in any of the shares mentioned. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Amazon. The Motley Fool UK has recommended Morrisons and Tesco and recommends the following options: long January 2022 $1920 calls on Amazon and short January 2022 $1940 calls on Amazon. 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.

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