Should I buy Tesco shares today at 224p?

The Tesco share price has drifted lower since February. Roland Head reckons this market-leader looks cheap and is tempted to buy the stock for income.

| 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.

Tesco (LSE: TSCO) shares have delivered a pretty dull performance so far this year. The share price of the UK’s largest supermarket has dropped by almost 10% since 15 February, when the company completed a £5bn cash return to shareholders after the sale of its Asian business.

City analysts expect the supermarket’s growth to flatten out after last year’s pandemic performance, which saw sales surge. However, I’m tempted by Tesco’s reliable cash flows and big market share. I’m also interested in the 4.5% dividend yield — I think this could be a good passive income stock.

Keeping last year’s gains

Supermarkets experienced a massive surge in demand last year. The combination of lockdown, working at home, and the closure of the hospitality industry meant that households suddenly needed more of everything. All at once.

This unprecedented situation lifted Tesco’s group sales by 7% last year, while its UK and Ireland sales were nearly 9% higher. Sales were never likely to keep rising at this rate, but I was hoping that Tesco would be able to hold onto last year’s gains.

How are things going so far? In its June trading update, Tesco said that retail sales for the three months to 29 May rose by 1% compared to 2020, but were 8.1% higher than in 2019. This suggests to me that Tesco has held onto the extra business it gained last year and is now returning to more normal trading. That seems like a decent result to me.

What comes next?

I think the big challenge for new CEO Ken Murphy will be to maintain the company’s momentum.

Tesco is already by far the UK’s largest supermarket, with a market share of 27%. I don’t think there’s any risk of second-placed Sainsbury (15% share) catching up. Meanwhile, the extra challenges created by the pandemic will hopefully soon start to ease.

What can Tesco aim for next? Murphy has big shoes to fill after the success of turnaround CEO Dave Lewis. So far, all we know is that he plans to make shareholder returns a priority and will not take too many risks chasing growth.

Given the company’s large size, this strategy makes sense to me. But rivals Morrisons and Sainsbury are both in good shape too, in my view. They won’t stand still. Discounters Aldi and Lidl are also continuing to open new UK stores, adding to the competition.

Tesco share price: cheap as chips?

Murphy expects Tesco’s profits to return to 2019/20 levels this year. That suggests that the group’s operating profit will rise by around 20% this year, as the extra costs caused by Covid-19 start to fall away.

City analysts expect Tesco’s dividend to rise by around 9% to 10p this year, giving the stock a forecast yield of 4.5%. My sums suggest this payout should be comfortably covered by the group’s cash generation. This might open the door for a bigger dividend increase, or perhaps share buybacks.

In my view, Tesco shares look cheap at current levels. Although the company’s growth is likely to slow, I think there’s enough upside potential from current levels to make the stock a decent investment. I’d be happy to buy the shares at 224p today.

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.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Morrisons 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.

More on Investing Articles

Investing Articles

3 ideas to help investors aim for a million-pound Stocks & Shares ISA

The UK has a growing number of Stocks and Shares ISA millionaires, and this plan may be one of the…

Read more »

Illustration of flames over a black background
Investing Articles

2 red-hot UK growth stocks to consider buying in April

These two growth stocks are performing well, but can they continue to deliver for investors through 2024 and beyond?

Read more »

Charticle

Is JD Sports Fashion one of the FTSE 100’s best value stocks? Here’s what the charts say!

The JD Sports Fashion share price remains a wild ride during the first quarter. Could it be one of the…

Read more »

Investing Articles

Could the JD Sports Fashion share price double in the next five years?

The JD Sports Fashion share price has nearly halved in the past five years. Our writer thinks a proven business…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

If interest rate cuts are coming, I think these UK growth stocks could soar!

Falling interest could be great news for UK growth stocks, especially those that have been under the cosh recently. Paul…

Read more »

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

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 »