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The Tesco share price is down but I’d still buy

Image: Tesco

The Tesco (LSE: TSCO) share price is firmly in negative territory this morning. That’s despite the FTSE 100 supermarket giant issuing a fairly encouraging update on trading. Before explaining why I think the company remains a decent addition to a diversified portfolio, let’s take a look at the latest numbers. 

Trading update

Building on the momentum seen in 2020, Tesco revealed that business had continued to be “strong” over the 13 weeks to 29 May.

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In the UK and ROI, sales rose to just over £12.4bn during the quarter. This was a 1.3% increase on a one-year like-for-like basis. That’s certainly no disaster given the strong comparatives from 2020. On a two-year like-for-like basis, the figure was up 8.7%.

In the UK alone, Tesco noted that the 9.3% rise in like-for-like sales over two years shows just how much the company benefited from people eating more at home compared to before the pandemic arrived on these shores. The 9.2% increase in sales at the company’s wholesale business (Booker), thanks to a recovery in the hospitality sector, was also worth noting and bodes well for the future.   

What now?

Commenting on today’s numbers, CEO Ken Murphy declared that Tesco’s guidance on profit had not changed. 

Of course, nothing can be guaranteed. While the grocery sector is a lot more defensive than other parts of the market (everyone still needs to eat), there’s still a very real possibility that sales at Tesco and its peers will slow more than expected. This is particularly the case for online orders, which exploded over the last year.

In fact, there’s evidence that this is already happening. Today, the £18bn cap revealed that sales growth has “moderated” over the last couple of months in line with the phased lifting of restrictions. This may help explain why the Tesco share price is retreating today.

Although market commentators disagree over whether inflation will persist or not, a rise in food prices may also hit margins for a while. Naturally, attempting to pass these increases on to customers won’t work because of how competitive the industry is. People will just shop elsewhere. 

Best buy

Investors like me are spoilt for choice when it comes to investing in this sector. In addition to Tesco, there’s also FTSE 100 peer Sainsbury’s and FTSE 250 rival Morrisons. Given its technical expertise, a more growth-oriented investor may also be attracted to the potential of Ocado

Personally, I’m still inclined to believe that Tesco remains the best of the bunch. As far valuations go, the FTSE 100 stock trades on a little less than 13 times forecast earnings. That’s slightly lower than Morrisons (13 times earnings) and only slightly more than Sainsbury’s (12 times earnings). Based on its ongoing dominance of the market, I can’t help but think Tesco gives investors the most bang for their buck. 

But it goes beyond valuations. As I explained last month, the notable short interest in both Sainsbury’s and Morrisons make them unattractive options, in my view. For all its promise, Ocado is still not consistently profitable. 

In addition to its valuation, Tesco also offers a great dividend stream. Analysts currently have the company returning 10.5p per share in FY22. That’s a yield of 4.6% based on Tesco’s share price right now. 

All told, this remains my first choice in the sector and I’d feel comfortable buying the stock today.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Morrisons, 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.

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