Tesco shares: 3 risks you need to know about

union jack flag and iconic Big Ben at the palace of Westminster, London
union jack flag and iconic Big Ben at the palace of Westminster, London

Tesco(LSE: TSCO) is a stock that divides opinion. On the one hand, there are plenty of investors who believe the supermarket giant is turning things around after a rough patch a few years ago, and that the share price offers considerable value right now. On the other hand, there are those who believe the investment case for Tesco shares is still quite risky.

Personally, I’m in the latter camp. Analysing the investment case for the company, I’m not convinced the shares are worth buying at current levels. Here’s a look at three key risks that concern me in relation to Tesco.

The German discounters

In my view, the biggest risk remains the growth of the German low-cost supermarkets – Aldi and Lidl. These two discount supermarkets have captured a significant amount of market share over the last decade and I can see this trend continuing.

Just look at results over the recent Christmas period. While Tesco managed to generate like-for-like sales growth of 2.2%, Aldi – now the fifth-largest UK grocer – smashed this to record sales growth of 10%. That’s a clear difference.

Aldi already has around 830 stores in the UK and it plans to open 70 more this year, with a goal of 1,200 stores by the end of 2025. I see this growth strategy as a real threat to Tesco, especially now the German company is focusing on enhancing its premium range.

A Brexit recession

The next major risk I see to Tesco is the threat of a Brexit-related recession. Now, at this stage, no one has any idea what’s happening with Brexit, or how it will affect the UK economy. However, if Brexit was to result in a UK recession, I believe Tesco could be impacted negatively.

You may be wondering why the business would be affected in the event of a recession. After all, people still need to eat, right? That’s true. However, the way I see it, a recession would lead to job losses which, in turn, would push consumers towards lower-cost food retailers (did I mention the German discounters!?). This could impact Tesco’s top line.

Asda/Sainsbury’s merger

Finally, don’t forget the potential merger of Asda and Sainsbury’s. Of course, this isn’t a done deal yet, as the Competition and Markets Authority (CMA) is still looking into the deal (it’s due to publish its final report in early March). However, if it is approved, this would almost certainly be a blow for Tesco, as a combination of the UK’s second- and third-largest supermarkets would create a powerful entity (with a higher market share than Tesco) and give the group considerable buying power. This means that it would be able to offer lower prices and, potentially, steal market share from Tesco.

So, overall, I see clear risks to the investment case for Tesco. With the shares trading on a P/E ratio of 16 and offering a prospective yield of just 2.3%, I’m not seeing enough value to warrant buying the shares at the moment.

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Edward Sheldon has no position in any 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.