Taking a quick look at Tesco‘s (LSE: TSCO) share price lately, it looks pretty cheap to me. Its stock performance took a nosedive in mid-February. Now, it is trading at 226p, down 25% from 299p a year ago.
As a value investor, this performance has attracted my attention. I’m always looking for cheap shares that can diversify my portfolio, and it seems as if Tesco might qualify.
However, Tesco’s stock price doesn’t tell me much about its underlying performance. Just because it is trading lower today than 12 months ago, doesn’t mean the stock is worth buying. So I need to dig deeper.
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Looking at Tesco’s financials
The first step I take in understanding if Tesco is undervalued is checking its financials.
Tesco recently released its preliminary results for 2020. Headline sales excluding fuel were up 7.1% to £53.4bn, driven by an 8.8% rise in its core UK and Ireland stores. However, Tesco Bank revenue fell by £400m, or 31.2%, during the pandemic. Adjusted operating profit also dropped to £1.8bn from £2.5bn in 2019-20, down 28.1%. This was largely due to £900m of extra costs relating to Covid-19.
However, it was not all doom and gloom. Covid-19 has been dreadfully difficult for almost every industry, grocery included. Tesco has implemented massive infrastructural and behavioural changes to combat the pandemic. But the supermarket reckons only a quarter of these extra costs should continue into 2021-22. If this is the case, then Tesco has predicted that its bottom line could see a boost of £675m from lower expenses.
To me, 2020 was a Covid-induced blip.
Tesco’s share price potential
Despite the rise of discount competition, Tesco is still dominant in the UK grocery market with 27% market share. Although it operates in a mature market, meaning that growth will be slower, I’m not worried. Its market dominance and 9.15p per share dividend payment make it an optimal retirement stock for me.
And it does still have growth opportunities. Tesco is focusing on growth by opening new Express format stores. These are smaller shops that typically have less choice than their larger counterparts. I think this enables Tesco to boost its brand and distribution network at lower cost. As well, Tesco has entered the growing plant-based meat industry, a sector that analysts expect to be worth $17bn globally by 2024.
Continued innovation and market opportunities such as this will only help to see Tesco’s share price grow.
Risks to Tesco’s share price
As a British grocery chain at the top, it can be very easy to fall. Stiff competition from the likes of Sainsbury’s and Morrisons pose a significant threat. The German players are also making strides in the British market, with Lidl and Aldi both gaining market share in 2020.
And Covid-19 is still a problem. Tesco’s profits could suffer if more infectious variants of Covid-19 emerge, as we’ve seen in Brazil, and postpone the global reopening. Conversely, Tesco’s sales may take a short-term hit if pubs, bars, and restaurants boom after reopening.
So, is it too cheap?
I believe that Tesco represents a great discount buying opportunity right now. This is a dividend-paying market leader that has managed a global pandemic pretty well from my perspective. Any dip in its price is short-term in my opinion, so I’d be happy to buy it at these prices.
