Tesco (LSE: TSCO) shares have fallen by 54% in twelve months, thanks to the firm’s crumbling profits and damaged credibility.
The question for investors is whether the worst is now over: is it time to buy Tesco?
Let’s start with a look at the supermarket’s current and historic valuation:
Should you invest £1,000 in Tesco right now?
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| P/E ratio | Current value |
|---|---|
| P/E using 5-year average adj. EPS | 5.8 |
| 2-year average forecast P/E | 9.6 |
Source: Company reports, consensus forecasts
It’s clear that Tesco’s earnings are expected to be lower in the years ahead than they have been in the past, but even allowing for this, Tesco looks very cheap.
My concern here is that analysts’ forecasts tend to lag behind the trend, rather than anticipating it. The current consensus estimate for 2014/15 earnings is around 17.9p, but in my view a figure of 15-16p is more likely, which would put Tesco on a forecast P/E of around 11. This seems high enough, to me.
What about the fundamentals?
Although it’s useful, the P/E ratio isn’t the only way of valuing a business. Let’s take a look at some of Tesco’s other key numbers:
| Metric | 5-year compound average growth rate |
|---|---|
| Sales | +2.2% |
| Pre-tax profit | -6.6% |
| Adjusted earnings per share | +0.3% |
Source: Company reports
These figures suggest that Tesco’s profits have been under pressure for a long period — something we now know to be very true, thanks to Tesco’s admission that it has overstated its trading profits for a number of years.
Tesco’s once-great dividend has been sacrificed: the firm has cut the interim payout by 75% and is expected to cut the final dividend by a similar amount, giving a forecast total payout of 5.2p, which equates to a 3% prospective yield.
Buy on book value?
Tesco’s share price has now fallen so far that it is trading in-line with its book value, which last week’s interim results showed to be 166p per share.
However, sector peers Wm. Morrison Supermarkets and J Sainsbury currently trade below both their book value and their tangible book value, which excludes goodwill and other intangible assets such as brands.
Tesco’s tangible book value per share is just 117p per share, suggesting that further falls could be possible.
Strategy black hole
Tesco’s new chief executive, Dave Lewis, has yet to reveal his strategy for the business or his plans for strengthening the company’s balance sheet, which has become overburdened with debt.
Until we get more clarity on the future of the business, it’s hard to decide whether to call buy — but my instinct at the moment, as a shareholder myself, is to wait a little longer before buying more Tesco shares.
