Tesco share price: FTSE 100 bargain or value trap?
The Tesco (LSE: TSCO) share price dropped 9.6% on Wednesday when the company released its latest half-year results. Now trading at around 215p (mid-afternoon Friday), the shares are well below their 52-week high of 266p, made as recently as August.
Furthermore, having been changing hands at 230p or so when Dave Lewis took the reins as chief executive on 1 September 2014, you could be forgiven for thinking that Tesco is an ongoing value trap for investors. I don’t think this is the case at all and I’d be happy to buy a slice of the business at the current time and price.
Underlying business progress
Back in the summer of 2015, when the new chief executive was addressing his first Tesco AGM, the shares were at around the same level as today. The forward 12-month price-to-earnings (P/E) ratio was then 21.6 and the prospective dividend yield was 0.7%. Today, at the same share price, we’re looking at a forward P/E of 13.4 and yield of 3.1%.
Lewis had impressed me (and many others) from the outset with his strategy to get Tesco back on track. I think the market bought into it to such an extent that it pushed up the share price ahead of events early on (that P/E of 21.6) and has done so from time to time since. However, the current P/E of 13.4 is testament to the underlying business and earnings growth made over the period.
What we have today is a company valued at a level from which future periods of earnings growth (an annual high-teens percentage forecast for the next two years) can drive the share price sustainably higher. We also now have a decent 3.1% dividend yield, with the payout forecast to grow strongly in the coming years.
Targets in sight
What of the downbeat market response to the latest results? It’s not something I’m too worried about. The key thing for me is that the core business performed in line with expectations. I reckon an 11th consecutive quarter of like-for-like sales growth in the UK and Republic of Ireland puts the lie to the idea that Tesco’s transformation may be running out of road in the face of the continuing expansion of discounters Aldi and Lidl.
I view the success of the core business (and management’s “delight” with the performance so far of its Booker acquisition) as more significant than the recently-launched trial of the new Jack’s discount brand and store format — interesting though that experiment will be.
The negatives in the latest results were further afield where performance was hurt in Central Europe by changes to Sunday trading regulations in Poland, and in Asia by a tough trading environment in Thailand, including the issuance of government welfare cards which cannot be redeemed in modern retail chains. However, Tesco is already addressing its problem areas on foreign soil and rebasing for future growth.
Crucially for me, the group remains firmly on a trajectory to meet the targets management set out in October 2016. These are, as it reminded us: “To reduce our costs by £1.5bn, to generate £9bn of retail cash from operations and to improve Group operating margins to between 3.5% and 4.0% by 2019/20.” I’m confident management can hit these targets and that the shares can rise strongly from their current level.
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G A Chester 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.
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