For many years, I was a big fan of supermarket giant Tesco (LSE: TSCO), especially when ex-boss Sir Terry Leahy was at the helm. Alas, after a series of missteps and mess-ups (including a major accounting scandal), Tesco’s fortunes waned. After peaking above 625p in November 2007, the Tesco share price underwent a long and rocky slide. By late December 2015, it had crashed below 180p. For the past five years, the shares have been range-bound between roughly 190p and 340p. But I see a strong, stable business at the heart of Tesco. What’s more, I think its shares might outperform the wider FTSE 100 index in 2021, for the first time in many years.
The Tesco share price falls 2% after results
On Wednesday morning, Tesco released its preliminary results for 2020/21. Headline sales excluding fuel were up 7.1% to £53.4bn, driven by an 8.8% rise in its core UK and Ireland stores. But revenues at Tesco Bank slumped in the pandemic, falling by £400m (31.2%). Adjusted group operating profit dropped to £1.8bn from £2.5bn in 2019/20 (down 28.1%). This was largely due to £900m of extra costs relating to Covid-19. Clearly, investors were slightly disappointed with Tesco’s full-year numbers, as the share price dip on Wednesday showed.
This giant should bounce back in 2021/22
As I write, the Tesco share price stands at 227.35p, down 4.75p (2.1%) on the day. But I think these results were pretty good, given the huge effort and cost of the firm’s rapid adaptation to social distancing, infection-control measures, and the surge in online shopping. Furthermore, the swing at Tesco Bank to a £175m loss from a £193m profit in 2019/20 shouldn’t be repeated. Indeed, as the economy recovers post-Covid-19, banking profits are expected to soar.
Despite pubs, bars and restaurants being locked down for long periods, sales gains were wiped out by additional costs. Thus, diluted earnings per share (EPS) fell to 11.94p in 2020/21, down 35.8% from 18.6p in 2019/20. But the supermarket reckons only a quarter of these extra costs should continue into 2021/22. If this is the case, then Tesco’s bottom line could see a boost of £675m from lower expenses. This would lift EPS and should help to support the future share price.
What next for Tesco?
For now, the business has decided to hold its cash dividend at the 2019/20 payment of 9.15p per share. Based on the current Tesco share price of 227.35p, this equates to a dividend yield of 4% a year. But, given the strength of the group’s balance sheet (net debt fell by 2.8% to £12bn), I see scope for future dividend hikes. Again, this — or share buybacks — could given the shares a long-awaited boost.
Likewise, if the UK enjoys a sustained, multi-year economic boom after Covid-19 is under control, then this should spell good news for Tesco’s earnings. Conversely, company profits could suffer if more infectious variants of Covid-19 emerge, postponing the global partying. Also, Tesco’s sales could decline if pubs, bars and restaurants boom after reopening. And let’s not forget the inexorable march of discounters Aldi and Lidl.
Still, with Tesco gaining momentum, I see potential for higher returns for shareholders. That’s why I see the Tesco share price as a winner in 2021/22. Hence, I’d happily buy these shares today.
Cliffdarcy has no position in any of the shares 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.