Shares in Tesco (LSE: TSCO) have risen by just 1% this year which, after the company’s excellent start to the year, is very disappointing. In fact, by April Tesco had risen by 33% since the turn of the year, but has lost nearly all of those gains in the following six months.
Perhaps the key reason for this is a gradual realisation that Tesco is a long term project, as opposed to a quick turnaround. Certainly, its new strategy appears to be sound, but the excitement which rushed through the company’s investors earlier this year appears to have given way to a realisation that Tesco will take time to shed its non-core activities, make the efficiencies required to become a leaner business, as well as appeal to customers who have improved budgets due to real-terms wage growth.
As a result of its share price fall, Tesco now trades on a price to earnings growth (PEG) ratio of just 0.4, which indicates that its shares could easily put back on the 33% gains made earlier in the year. An increase in dividends could be a major catalyst to help it to do so, since Tesco currently yields just 1% but pays out only 18% of net profit as a dividend. As such, it has vast scope to raise shareholder payouts and, in doing so, could convince the market that it is making improvements as a business and also that its management team has confidence in the company’s long term financial future.
Similarly, Balfour Beatty (LSE: BBY) is attempting to turn its financial performance around, although unlike Tesco it is expected to report a loss for the current year. This would make it three years in a row of a red bottom line and, while the company is expected to return to profit next year, much of this improvement already seems to be priced in via a forward price to earnings (P/E) ratio of 19.4.
Clearly, Balfour Beatty is gradually turning its fortunes around and today’s £6m contract win to carry out road improvement works in Cambridgeshire is further evidence of it moving in the right direction. However, even though the UK economy is set to deliver further growth and infrastructure projects are likely to gain a boost from this, Balfour Beatty seems to be overpriced given its poor track record. And, with the support services sector having numerous UK-focused, high quality businesses which are very profitable, there seem to be better opportunities elsewhere.
Meanwhile, today’s update from InterContinental Hotels (LSE: IHG) has been warmly received by the market, with the company’s shares rising by 4%. That’s mostly because revenue per available room (RevPAR) increased by 4.8% on a constant currency basis, with the company experiencing its largest third quarter hotel signings since 2008. This means that it has now signed up 16k of the 218k room pipeline which is a key target for the business, with the third quarter seeing a rise in net rooms available of 4.3%.
As a result, InterContinental Hotels appears to be on-track to meet its 10% earnings growth forecast for the current year, as well as its additional 12% rise in net profit for 2016. This puts it on a PEG ratio of 1.5 which, for a business that has an excellent track record of reliable growth, seems to be a very fair price to pay.
