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Should I buy Tesco shares now?

Harvey Jones
·3-min read
Compass pointing towards 'best price'
Compass pointing towards 'best price'

Tesco (LSE: TSCO) shares have had a solid pandemic, by and large. Not fantastic, or amazing, but solid. They trade at roughly the same level they did one year ago, just before the nightmare began. By comparison, the FTSE 100 as a whole is down around 14%.

Shares in Tesco have also beaten the index measured over five years, and rather easily. Its stock is up more than 50% in that time, while the FTSE 100 grew just 12%. Past performance is no guide to future returns, but this is still impressive, given the troubles that affected the UK’s largest grocery chain before Dave Lewis took the helm in 2014.

Many investors now buy Tesco for dividend income, rather than share price growth. This happens when big blue-chips get to a certain size. Getting bigger gets harder. Previously, management tried to get round this by conquering the world, but that strategy came to grief in the US and Asia. So now it depends primarily on the hard-pressed British consumer for growth.

Still the UK’s top grocer

Tesco and the other supermarkets deserve plaudits for feeding the country, keeping shelves stacked and deterring panic-buying. That doesn’t automatically make them good investments, though. So before deciding whether to buy Tesco shares, I’ll put that aside and look at the fundamentals.

Tesco is still the UK’s largest supermarket, by a long chalk. It has market share of 27.3%, according to latest Kantar research, well ahead of second-placed Sainsbury’s at 15.3%. Better still, Aldi and Lidl’s breakneck growth has flattened over the last 18 months, although they remain a major threat to the dominance of the UK’s ‘big four’.

New boss Ken Murphy has inherited a well-run company, in contrast to the chaos Dave Lewis had to sort out. The group had a good Christmas, with online sales up 80% year-on-year. The trend is set to continue and as a leader in the field, Tesco should capitalise on this. Lidl still does not do home delivery, although Aldi does.

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I’d buy Tesco shares today

Tesco’s ‘finest’ range of premium own-brand products is also growing strongly, which suggests to me that that consumers are still willing (and able) to pay a little extra to treat themselves. One concern I have is that Tesco’s sales will fall once the lockdowns are finally over, as people buy more food and drink in pubs and restaurants, hitting its shares.

Tesco shares are not exactly expensive today, trading at 12.5 times forward earnings. It also pays a rather good dividend of 4%, covered 1.9 times by earnings.

Management plans to use proceeds from its recent disposals in Malaysia and Thailand to fund a £5bn special dividend. But operating margins are thin at 3.9%, and forecast to get even thinner, falling to 3.1%. Sadly I suspect there is little Tesco can do to improve them substantially, given tough competition in the grocery sector.

The big long-term worry is whether Amazon will steam into food home deliveries and create havoc with established players. Investors have been fretting about this for years, and the big day has yet to come. I think Tesco has the size and scale to fight back, though, and would buy its shares for long-term income and with luck, a little share price growth too.

The post Should I buy Tesco shares now? appeared first on The Motley Fool UK.

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Harvey Jones 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.

Motley Fool UK 2021