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What’s next for the Tesco share price?

A Tesco employee chatting with a customer
Image: Tesco

The Tesco (LSE: TSCO) share price has underwhelmed over the past year. Even though the company has had somewhat of an unfair advantage compared to its high street peers throughout the pandemic, the market doesn’t seem to have noticed. 

Over the past 12 months, the stock has produced a total return of 7.9%. Meanwhile, over the past three years, it’s returned -1.3% per annum.

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Over the past year, the FTSE 100 has returned 19.8%, including dividends, while returning 1.4% per annum over the past three years. 

Following this performance, it’s not surprising some investors are avoiding the stock. However, I think Tesco presents an attractive investment opportunity. 

Slow and steady wins the race

I’ll start by saying I don’t think Tesco will produce the sort of returns for my portfolio that I’d expect from a high-growth tech stock. It is just not that kind of business. 

Instead, I think Tesco is a slow and steady company that would sit well in my portfolio as a foundation stock. As the country’s largest supermarket retailer, it has a unique competitive advantage. Not only does it have the largest store network, but it also has access to the most significant number of customers, the most extensive distribution network, and more customer data than its peers. 

These competitive advantages suggest the company can maintain its position at the top of the market, which gives the Tesco share price a defensive nature. 

The company’s economies of scale are also helping it generate vast amounts of cash. Last year, the group produced £1.2bn of free cash flow. This will underpin the dividend and provides the firm with additional capital to fuel other shareholder returns, such as buybacks. 

Tesco share price risks

Despite all of the above, I should note that the company is exposed to several risks. For example, staffing costs are its most significant expense. Therefore, rising wages could impact profit margins. If the cost of products also rise, and the group has trouble passing these costs onto customers, margins may also fall. 

Then there are business rates to consider. This is another high cost for the group. If rates rise, the volume of cash available for distribution to investors will fall. 

Despite these risks, I think the Tesco share price is incredibly attractive for the reasons outlined further above. While it’s unlikely the stock will make investors rich overnight, its 4.3% dividend yield looks incredibly compelling in the current interest rate environment. I think this dividend’s here to stay, considering all of the above. 

And in the long run, I think the company’s earnings growth should at least match inflation. Historically, the Bank of England is targeting an inflation rate of 2%. As such, these numbers suggest the stock could return 6.3% per annum through a combination of earnings and dividend growth. This suggests to me the outlook for the Tesco share price is one of slow and steady growth as the stock reflects earnings expansion. 

However, this is just a forecast. There’s no guarantee the stock’s earnings growth will match inflation, or its dividend will remain at 4.3%. Dividends can be cut at a moment’s notice. 

So, overall, I’d buy this company for my portfolio today despite its lacklustre performance over the past three years. As a defensive income play, the Tesco share price ticks all the boxes for me. 

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Rupert Hargreaves 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.

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