Stepping into a Tesco (LSE: TSCO) store over the past few weeks would hardly have given me the sense of a business performing weakly. The supermarket giant continues to hold a commanding position in its market. Yet last year, Tesco shares lost 24% of their value.
Given my expectation that grocery sales will remain strong and Tesco has some key advantages in this market, could the shares be a bargain buy for my portfolio?
Price and value
Just because a share is cheaper than it once was does not necessarily mean it is good value.
However, I do think Tesco looks attractively valued at the moment. Currently, the firm’s market capitalisation is under £17bn. Last year, it reported post-tax profits of £1.5bn. That means the price-to-earnings ratio is around 11. It looks like good value to me.
But that valuation is based on last year’s earnings. What if the business does worse this year and beyond?
At the sales level, although this is a risk I see it as a fairly small one. Demand for everyday necessities sold by supermarkets tends to be resilient even when the economy is performing poorly. The current high levels of inflation mean that sales revenues are likely to grow even if volumes are flat or fall slightly.
My concern is more about earnings than revenue. Inflation adds costs for Tesco, but as shoppers tighten their belts it may be hard to pass on all of those extra costs in the form of price rises. Meanwhile, increased competition from rivals like Aldi and B&M could continue to squeeze profit margins for the firm.
This seems to have been reflected in its results for the first half of its current financial year. While revenue (excluding VAT) rose 6.7% compared to the same period last year, pre-tax profits were down 64%.
Reasons to own the shares
Despite my concerns about some of the short-term risks, in the long term I continue to think there is an attractive investment case here.
Tesco is by far the biggest supermarket operator in the UK. That gives it economies of scale and means it has a large customer base that can help drive future profits. Its brand has broad recognition and the company’s renewed focus on its core business after reducing its international exposure could help sharpen management focus.
Digital retail has grown in importance but there too, its strengths could help it build market share over the years to come.
The interim dividend rose 20%. If I buy the shares for my portfolio today, the expected yield would be over 5%. I regard that as attractive.
Given those strong business attributes, a good yield and what I see as an attractive valuation, I would consider buying Tesco shares right now if I had spare cash to invest.
The post Tesco shares lost 24% last year. Should I buy in January? appeared first on The Motley Fool UK.
C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended B&M European Value and Tesco Plc. 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 2023