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Should I buy Tesco shares today at 224p?

·3-min read
Tesco fruit and veg

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.

The post Should I buy Tesco shares today at 224p? appeared first on The Motley Fool UK.

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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.

Motley Fool UK 2021

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