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The Tesco share price: is a buyout on the cards?

A shopping basket filled with Tesco own-brand goods
Image: Tesco

The Tesco  (LSE: TSCO) share price is looking like a great defensive play to me right now. At 256p today, it’s risen 15% over its price of 223p on 1 July. That’s not a bad return in less than three months. 

For the wary investor, it’s worth mentioning that the 30% fall in February was the result of a special dividend paid out from the sales of its Asian businesses. As £5bn was returned to investors, the Tesco share price fell by roughly the same amount.

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But market analysts expect revenue to increase by over 150% in this fiscal year. So I think it’s now looking undervalued.

Every little helps

First off, Tesco holds 27% of the UK market share, making it the largest grocer in the UK. It’s also the third-largest retailer in the world when measured by gross revenue. With such a strong position, I think the company is a safe bet as a defensive stock. And it boasts a respectable 3.9% dividend, higher than the FTSE 100 average. 

It’s true that its market share has been eaten away recently by the likes of Aldi and Lidl. But Tesco has benefitted over the past two years from a strong demand for online delivery. In fact, it reported a 13% increase in like-for-like sales in Q1, making it the market leader in online groceries as well. And it’s also trialing zero-waste stores, as part of an ongoing commitment to reduce plastic waste. I suspect this could appeal in the long-term to environmentally conscious consumers.

I’d also buy the shares for the possibility of a private equity buyout. Its former CEO, Sir Terry Leahy, is the advisor for Clayton, Dubilier & Rice (CD&R), the private equity firm currently in the midst of a takeover battle for Morrisons. Yes, it would cost more than its smaller rival. But the Morrisons bidding war has shown that UK supermarket shares may be significantly undervalued. 

Risky business for the Tesco share price

With a lorry driver shortage of at least 100,000, there’s the possibility that Tesco shoppers will once again experience the empty shelves that caused panic in the early days of the pandemic. The grocer has already introduced £1,000 starting bonuses for new drivers. And shortages are likely to be compounded by increased border bureaucracy as a result of Brexit. If the lorry driver deficit isn’t resolved, Chairman John Allan has predicted that “there may be some shortages at Christmas,” the most important trading time of the year. 

And I think in the long-term that Tesco is going to be forced to offer higher wages, to attract staff amid the wider labour shortage. This means that either profit margins will fall, or prices are going to rise. If our fragile economic recovery hits a wave, it’s also reasonable to assume that customers will be less likely to splash out on higher margin premium goods.

However, I’d still buy the Tesco share price. Its defensive nature as a food retailer appeals to me as an investor who believes a market crash may be imminent. A possible buyout is just the icing on the cake.

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Charles Archer 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.

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