It’s unwise to follow blindly ‘buy’ or ‘sell’ recommendations from City analysts in isolation.
However, these recommendations from professional analysts, who have greater market expertise and specific knowledge about the companies they follow, can be highly insightful and form a great starting point for further research.
One company that the City’s top analysts just can’t seem to agree on is Tesco (LSE: TSCO). Price targets vary from 169p to 295p, and it’s difficult to decide which group of analysts has put together the most convincing argument for the company.
Bear case
Analysts at investment bank Credit Suisse believe that Tesco’s shares are worth no more than 169p. They make the case that the group’s UK operations are loss-making and barring an aggressive restructuring, it will take some time for Tesco’s UK stores to return to profit.
What’s more, analysts at Credit Suisse are concerned about Tesco’s ability to return cash to investors.
However, it is interesting to note that before Tesco issued its profit warning last year, Credit Suisse was one of the company’s most vocal supporters. During 2013 the bank’s analysts stated that, “We think growth/capital discipline can co-exist” and Tesco’s “exceptionally strong” shareholder returns over the last 20 years have been overlooked, but growth remains “engrained in company culture“. As we’ve since found out, this turned out to be a misleading statement.
And after misleading investors two years ago, it’s easy to take Credit Suisse’s view on Tesco with a pinch of salt.
Bull case
At the other end of the spectrum, HSBC’s analysts believe that Tesco’s shares could be worth as much as 295p. HSBC believes that the company’s outlook has improved notably under new CEO Dave Lewis.
Even though Lewis has only been in the role for a few months, he is already winning over the City. Tesco’s sales have shown signs of strength recently, and the retailer has stopped losing market share. Also, HSBC notes that discounters Aldi and Lidl’s sales and market share growth is slowing from its year ago peak.
Moreover, HSBC’s analysts’ have picked out three key advantages Tesco’s has over almost all of its peers.
Firstly, Tesco has a buying power advantage over its peers, in other words, the retailer can achieve better margins than peers due to its bulk buying from suppliers. HSBC believes that for every £1bn in sales, all else being equal, Tesco can pocket an additional 0.3% profit compared to a smaller peer like Sainsbury’s.
The second advantage Tesco has over its smaller peers is economies of scale. HSBC’s analysts’ believe that if Tesco were to increase spending on advertising, for example, Sainsbury’s would have to spend almost twice as much as a percentage of sales to achieve the same reach and impact on consumers. The same goes for other fixed costs.
The third and final factor is again to do with size, specifically the size of Tesco’s distribution network. HSBC’s analysts’ believe that Tesco’s network of distribution centres, stores, employees, warehouses and lorry fleet, the company has an unrivalled logistical advantage over almost all of its competitors.
The bottom line
All in all, HSBC seems to present the most convincing argument and for that reason I’m inclined to support their price target of 295p for Tesco’s shares.
