Why I'd sell Tesco plc even after its best Christmas in nearly a decade
It was a Merry Christmas indeed for long-suffering Tesco (LSE: TSCO) as the grocer notched up its largest ever sales week in the UK over the festive period. But the company's shares are down more than 4% today following the results release, even as the group notched up a 1.9% rise in like-for-like sales over Christmas and 2.3% year-on-year increase for Q3 as a whole.
Investors turned negative on this positive sales momentum because results wildly underperformed consensus estimates. Tesco laid the blame for this underperformance squarely at the feet of poor consumer confidence knocking down demand for the general merchandise goods it sells. The numbers back this up as UK Christmas LFL sales of actual food items were up 3.4%, showing the grocer may be able to begin clawing back some of the market share losses that have continued through 2017.
However, I still believe that Tesco is far from the best stock out there to buy today. Its shares trade at a full 19.9 times forward earnings, which seems steep to me for what is a relatively low-growth, low-margin business. And unlike the glory days of the mid-2000s, the company is far from a dividend powerhouse with the consensus forward forecast of a 3.28p dividend in 2018 only yielding a miserly 1.6% at today's share price.
Furthermore, looking at the market as a whole, I still see turbulent times ahead for Tesco. The grocer is still ceding market share to discounters Aldi and Lidl, which increased their cumulative market share from 9.7% to 11.8% over the past year according to data from Kantar Worldpanel. While the UK's leading grocer can still boost profits by making internal cuts, its pricing power, and thus margins, will remain capped as long as discounters continue to steal away customers at a rapid clip.
This situation combined with low dividends and a pricey valuation are more than enough for me to avoid Tesco shares today.
Better late than never
Things are a bit brighter for online grocer Ocado (LSE: OCDO), whose share price has jumped over 70% since early November on the news that the group has finally signed a long-promised agreement to provide its services to a foreign grocer.
The agreement with France's Groupe Casino will see Ocado use its proprietary technology to build a customer fulfilment centre for the French grocer that will allow it to serve customers across France.
This agreement could prove a game-changer for Ocado. The group's expertise and patent-protected methods for taking care of the logistics for quickly and efficiently delivering perishable food items are of obvious value to grocery chains around the world looking to develop their own online delivery services.
If this deal with Groupe Casino works well and Ocado can sign further deals with other grocers, the company's stock could also see a step change in valuation as investors would look at it more as a high-margin, easily-scalable tech business than the low-margin grocer it is today.
For now there is no guarantee that this deal will be successful or highly profitable, so I would urge caution towards investing in Ocado while its UK business continues to post very low profits in a highly competitive sector.
If you prefer your investments to have no such problems with low profits, I recommend checking out the Motley Fool's Top Small Cap, which has increased earnings by double-digits fours years in a row.
And unlike Ocado and Tesco, this company has a very down-to-earth valuation of just seven times trailing earnings. To discover this under-the-radar growth and value stock for yourself, all you need to do is follow this link to receive your free, no obligation copy of the report.
Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.
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