Is Tesco PLC Still A Buy After The 2013 FTSE Bull Run?

Tesco PLC (LON:TSCO) should continue to reward income investors, despite its troubles, says Roland Head.

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2013 has been the year in which even the most hardened stock market bears have admitted that we’re in a five-year bull market — and it’s not over yet.

Although the FTSE 100 has slipped back from the five-year high of 6,875 it reached in May, it is still up 8.8% this year, and is 53% higher than it was five years ago. As Christmas approaches, I’ve been asking whether popular stocks like Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) still offer good value, after five years of market gains.

Back to basics

Of course, while the wider market has enjoyed a five-year bull run, Tesco shareholders have not. Shares in the UK’s biggest supermarket currently trade within 2% of their price five years ago, and even the supermarket’s legendary dividend — which grew for 28 years — was put on hold in 2012, and is also expected to remain unchanged this year.

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However, as potential buyers of Tesco today, we need to focus on whether Tesco stock is good value at its current price:

Ratio Value
Trailing twelve month P/E 24.7 (based on continuing operations)
Trailing dividend yield 4.6%
Operating margin 4.9%
Net gearing 52.8%
Price to book ratio 1.7

Tesco’s trailing P/E has spiked this year, as a result of the firm’s decision to exit its loss-making US operations and write down various assets last year. There are signs of strain elsewhere, too — Tesco’s net gearing of 52.8% is higher than J Sainsbury or Wm. Morrison Supermarkets, while its price to book ratio of 1.7 is also considerably higher than Sainsbury’s (1.3) or Morrison’s (1.2).

Tesco’s share price may be being supported by its attractive yield, to some extent; at 4.6%, it is higher than Sainsbury’s, and is roughly on a level with Morrison’s payout.

Turnaround in 2014?

Tesco’s earnings are expected to return to something like normal in 2013, with consensus forecasts indicating adjusted earnings per share of around 31.3p, placing the shares on a P/E of 10.4.

Further gradual improvement is expected in the 2014/15 financial year, including a modest dividend increase, which makes Tesco shares look potentially good value:

2014 Forecasts Value
Price to earnings (P/E) 10.0
Dividend yield 4.8%
Earnings growth 3.5%
P/E  to earnings growth (PEG) 8.9

In post-crisis Britain, UK supermarkets are fighting for a larger slice of a smaller pie, as average household incomes lag behind inflation, putting pressure on consumer spending.

This trend — plus the competitive nature of the supermarket business — means that Tesco’s turnaround won’t be a quick process. The firm’s low forecast earnings growth rate is all that realistic investors can hope for, in my view, but its reliable dividend remains appealing.

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Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

> Roland owns shares in Tesco but does not own shares in any of the other companies mentioned in this article. The Motley Fool owns shares in Tesco and has recommended shares in Morrisons.

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