Why I think the Tesco share price is cheap at 225p

After completing its turnaround before the pandemic, and a strong performance during it, G A Chester thinks Tesco shares are cheaply priced.

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At 225p, I think the Tesco (LSE: TSCO) share price is cheap. The company and the grocery market have both changed over the last year or so. Here, I’ll discuss these changes and explain why Tesco stock looks very buyable to my eye.

Increased focus

In recent months, Tesco has disposed of its businesses in Thailand and Malaysia (for £8.2bn), and Poland (for £181m). Based on continuing operations, just 7% of the group’s sales now come from international markets (Czech Republic, Hungary, and Slovakia).

This shift to an even greater focus on the UK and Ireland is one change from a year ago.

Tesco share price and company value

Another change is that Tesco paid shareholders a special dividend of £5bn from the proceeds of the disposed businesses. It also did a 15-for-19 share consolidation.

Just prior to the completion of the sale of the Thailand and Malaysia businesses in December, Tesco’s market capitalisation was £22.5bn (9.8bn shares in issue and share price at 230p). Today, the market cap is £17.3bn (7.7bn shares in issue and share price at 225p). The approximately £5bn difference in market cap but similar share price reflects the special dividend payout and share consolidation.

Grocery market

In addition to the changes within Tesco, there have been changes in consumer behaviour in the broader grocery market. Notably, a huge increase in online shopping because of the pandemic.

Tesco more than doubled its online capacity to 1.5m slots a week in the early days of the pandemic. For its financial year ended 27 February, online sales increased 77% from £3.6bn to £6.3bn.

Strategy

It’s taken about 10 years for Tesco to recover from complacency about the threat of discounters Aldi and Lidl, taking its core UK customers for granted, and milking the UK cash flows for growth expansion (notably the disastrous attempt to enter the US market).

However, as the pandemic was dawning, the company announced its UK turnaround was complete. This from a back-to-basics strategy of a relentless focus on customers, as well as rebuilding staff morale, and resetting relationships with suppliers.

Furthermore, since the pandemic, customer scores on quality, value, and satisfaction have risen materially, leading chief executive Ken Murphy to say the brand is “in the best shape it’s been for 10 years”.

Competition

With Tesco having grown UK market share during the pandemic, including “gaining customers from all key competitors”, there’s good momentum in the business. Nevertheless, there are risks.

The UK grocery market is, as the company acknowledges, “brutally tough”. Competition is an ever-present threat for Tesco. For example, Aldi and Lidl (handicapped by their lack of online ordering during the pandemic) could be resurgent as life normalises.

These two have aggressive new store opening plans. According to the Financial Times: “Recent analysis from JPMorgan estimated that Tesco stores providing 29% of group sales overlap with a discounter’s new store”.

I think the Tesco share price is cheap

Despite the tough competition, I reckon Tesco’s in a stronger position than it’s been for many years. It plans to reward investors with reliable dividends from its prodigious cash flows. In addition, it’s given strong hints of future share buybacks

Trading at 13 times this year’s forecast earnings and with a running dividend yield of over 4%, I believe Tesco’s shares are cheaply priced. They look very buyable to me at this level.

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.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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