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Does the Tesco share price make it a bargain?

Rupert Hargreaves
A bull outlined against a field

The Tesco (LSE: TSCO) share price has been on a roller coaster ride over the past 24 months. After starting 2018 at around 210p per share, the stock surged to nearly 270p in August 2018 before collapsing to about 190p by the end of the year.

In April 2019 it had recovered some of the ground lost, topping out at 253p, before declining again.

Since reaching this peak, the stock has slumped 15% excluding dividends, underperforming the FTSE 100 by around 11% over the same time frame.

Time to buy?

I will admit that after this decline, I am interested in the Tesco share price. As the largest retailer in the UK, the company has unrivalled economies of scale. What’s more, over the past five years, management has overhauled the business to make it a leaner, more efficient beast than it has ever been before. 

As a result of these actions, even though competition in the UK retail industry is at a level that has never been seen before, Tesco’s operating profit margin is still rising. Management believes it can hit 4% very shortly.

That being said, there is the looming threat of Brexit to consider. While a no-deal EU exit will likely disrupt every business in the country to some degree, Tesco is a logistics giant.

The company is used to navigating tricky customs checks and logistical challenges with its global operating footprint. As a result, I believe Tesco will be better placed than most to navigate Brexit in whatever form it may take.

The company has already started stockpiling operations and the acquisition of wholesaler Booker several years ago substantially enlarged the group’s storage footprint.

The company may even come out stronger than it went in if it can grab market share from competitors who struggle to adapt to the new operating environment.

Discount price

So overall, it looks to me as if Tesco is well-positioned to both maintain its position in the market and continue to grow earnings for the foreseeable future.

However, despite the company’s bright outlook, the stock is trading at a relatively undemanding 12.7 times forward earnings. For the past five years, investors have been willing to pay up to 20 times earnings for the stock. I think that’s a little high, but I would be willing to pay as much as 15 times earnings for this market leader. 

Based on current City estimates, earnings growth of 9% for the company’s 2021 financial year will put the stock on a forward P/E of 11.5. 

The City is predicting earnings per share of 18.7p for fiscal 2021. A multiple of 15 on this would give a price target of 280p, a potential upside of as much as 31% from current levels. On top of this capital growth potential, shares in the company also support a dividend yield of 3.8%. 

All in all, based on the above I think that after recent declines, the Tesco share price does look like a bargain at current levels.

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Rupert Hargreaves owns no share 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 2019