Why I think the Tesco share price is deeply undervalued

The Tesco share price looks cheap compared to some of its FTSE 100 peers, argues this Fool, who’d buy the stock today.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

I think the Tesco (LSE: TSCO) share price is one of the most undervalued in the FTSE 100. Today, I’m going to explain why I hold this opinion. 

Deeply undervalued

Tesco isn’t the most exciting business on the market. However, the company does provide an essential service to consumers around the UK through its supermarkets, wholesale business, and local stores.

Further, customers are incentivised to shop in Tesco stores through its Clubcard scheme. In recent years, the company has been boosting its Clubcard offer by combining financial services, mobile phones, and, of course, food shopping. The corporation increasingly provides discounts in store for these card holders as a way of offsetting cheap prices offered by rivals. 

By encouraging consumers to sign up for the Clubcard scheme, Tesco has also built a vast trove of its customers’ data. This information has given the group an edge over competitors. By using the data, it can provide tailored discounts to customers and streamline its inventory process. 

Put simply, Tesco has a substantial competitive advantage both in the size of the operation and the data available to the group, which it can use to make better decisions. 

But despite these advantages, the stock is only trading at a modest premium to its sector. The Tesco share price is selling at a price-to-earnings (P/E) ratio of 12.7, compared to 12 for Sainsbury’s and 12.4 for Morrisons. I think the firm deserves to trade at a significant premium to the sector, considering its advantages. 

What’s more, at the time of writing, the stock offers a dividend yield of around 4%. That’s above the market average and looks highly attractive in the current interest rate environment. 

The final reason why I think the Tesco share price is undervalued is its cash generation. The firm is aiming to produce a free cash flow of £1.2bn every year. This implies the stock is trading at a free cash flow yield of 6.8%.

By comparison, fellow FTSE 100 giant Unilever is trading at a free cash flow yield of 5%. To put it another way, Tesco is around 36% cheaper on a cash flow basis.  

Tesco share price risks

While I believe the stock is undervalued, I can see why some investors might give the business a wide berth. Key risks to its growth include rising costs, which could eat away at profit margins. The retail sector is also incredibly competitive. Tesco has the advantage today, but it may not last long.

These risks could hold back growth and damage those all-important profit margins, which may hurt the company’s dividend prospects. 

Still, despite these risks and challenges, I think the Tesco share price is deeply undervalued. As such, I’d buy the retail champion for my portfolio today as a value and income investment. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rupert Hargreaves owns shares in Unilever. The Motley Fool UK has recommended Morrisons, Tesco, and Unilever. 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.

More on Investing Articles

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »

Investing Articles

Are HSBC shares a FTSE bargain? Here’s what the charts say!

There are plenty of dirt-cheap FTSE 100 banking stocks for investors to choose from today. Our writer Royston Wild believes…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

Just released: Share Advisor’s latest ‘Hold’ recommendation [PREMIUM PICKS]

In our Share Advisor newsletter service, we provide buy, sell, and hold guidance for our universe of recommendations.

Read more »

Investing Articles

Investing £5 a day could help me build a second income of £329 a month!

This Fool explains how £5 a day, or one less takeaway coffee, could help her build a monthly second income…

Read more »