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Is this what will finally kill the Tesco share price?

Alan Oscroft
Businessman selecting a Sell symbol

Aldi is investing £1bn in a plan to open a new supermarket in the UK each week, on average, over the next two years. The reason? Speaking to the BBC, boss Giles Hurley said: “Almost 50% of the population of the UK doesn’t currently shop with us and they tell us the main reason for that is that they don’t have a store near us.”

Aldi saw sales rise £1.1bn last year, almost entirely from opening new stores. And with profits actually down 18% due to price cutting, it doesn’t look like there’s much organic growth to be had in the supermarket sector.

Should Tesco (LSE: TSCO) shareholders be worried? Aldi is fighting the price war very aggressively, while Tesco and the other big UK operators are targeting a range of price points. But, ultimately, when it comes to the weekly groceries, price is what counts for the majority of UK families.

Then there’s Aldi’s German rival Lidl. Only a few days ago I was surprised to see yet another store opening near me, in a prime city centre location with heavy footfall. It’s only about half a mile from another store (and just around the corner from an Aldi), but it looked very busy on the weekday afternoon I was passing.

Tesco

But aren’t I supposed to be talking about Tesco? Yes, and the closer I look, the more I find myself in a dilemma — because Tesco, examined in isolation, is looking increasingly like a tempting investment.

I’m cautious these days when I look at a turnaround prospect, simply because I’ve seen so many recoveries take a lot longer than I initially expected. Tesco is actually a good example, and I doubt many of us ever thought its return to earnings growth and progressive dividends would take this long.

But the evidence that it’s really happened seems overwhelming. In three excellent years, Tesco turned EPS of 4.06p at February 2016 into 13.65p by 2019. The dividend is coming back too, with the 3p per share paid in 2018, which delivered a modest yield of 1.5%, nearly doubling for February 2019, with the yield rising to 2.3%.

Forecasts suggest two more years of EPS growth of 8-10% per year, which would put Tesco shares on a P/E of 14.7 for February 2020, dropping to 13.4 a year later. And the dividends should keep rising well ahead of inflation, reaching a predicted yield of 3.8% for 2021.

Buy?

That looks a fair valuation to me, so why won’t I be buying Tesco shares? One reason is that this earnings growth rate is still in recovery mode, and can’t be sustainable over the long term — there just isn’t 10% growth per year to be had from UK groceries sales.

But the main reason is Lidl and Aldi. It’s now a crowed market with little organic growth potential, increasing price competition, and really not a lot of product differentiation (at least not in the bulk of the market). In those conditions, in any sector, I wouldn’t buy into a company that’s being soundly beaten in the race for market share, even if it’s currently the biggest.

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Alan Oscroft 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 2019