It’s hard to say how Tesco (LSE: TSCO) shareholders should be feeling these days. On the one hand, trading has been buoyant, evidenced by this month’s thoroughly decent set of results which showed a 6.7% increase in first-half profits to £494m.
On the other, the decision by CEO Dave Lewis to stand down after five years in charge has come as a shock to the market. Lewis has been credited with turning the company around following its accountancy scandal through a combination of cutting costs, the canny acquisition of Booker, and taking the battle to discounters Aldi and Lidl through the opening of Jacks.
Given the above, I’m asking whether it makes sense to say the business could double your money in time.
Reasons to be optimistic
In contrast to other top-tier firms who’ve recently lost their leaders, the way in which Lewis’s departure has been handled so far has been exemplary. Certainty over his successor (Ken Murphy) should help stabilise the share price and potentially succeed in bringing new investors on board, even if the new CEO faces the daunting challenge of keeping operating margins as high as they’ve been.
Another reason relates to Tesco’s defensive qualities. Put simply, people will always need to eat. Should the UK economy enter a prolonged sticky patch — Brexit-induced or otherwise — it doesn’t seem fanciful to suggest that a lot of investors might gravitate towards boring old food retailers. The fact Tesco continues to be the market leader by some margin may also be enough to convince prospective buyers it’s the safest horse to back.
And then there’s Tesco’s income credentials. Having been understandably cut by Lewis during the difficult years, dividends are back on the menu and quickly rising. This year’s mooted 8.1p per share cash return will be 41% higher than the previous year and would equate to a yield of 3.4% at the current share price. What’s more, this payout is likely to be covered just over twice by profits.
So, why might it not happen?
A simple argument against Tesco doubling your money relates to its size. With a market capitalisation approaching £24bn, asking the FTSE 100 juggernaut’s shares to rise 100% from here might be asking too much, particularly given that competition in this industry remains so fierce.
Yes, the aforementioned market share is appealing, but the possibility of rivals merging in the future shouldn’t be ignored simply because the Asda/Sainsbury tie-up was blocked. Should online giant Amazon step up its assault on the established firms, for example, things could suddenly become very tricky indeed.
History is also against the share price doubling. In the last 20 years, the stock has never breached the 500p mark. And, right now, I just can’t identify a catalyst that will generate such massive appreciation.
Lastly, there’s the valuation. Based on analyst expectations, the stock changes hands at 14 times earnings for FY20. That’s fairly average compared to the market in general, but it’s on the pricey side compared to its biggest rival Sainsbury’s, on a forecast price-to-earnings (P/E) ratio of 11.
In sum, I’m struggling to see how Tesco will double your money on anything but the very long term. That said, it would certainly be my preferred pick from the sector if I was looking for sustainable and growing dividends.
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Paul Summers 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