Britain’s largest supermarket, Tesco (LSE:TSCO), has had a shaky start to the beginning of the year. Consumers are expected to cut back on spending habits as economies are hit by rising inflation. And the Tesco share price has already slipped 12% in 2022.
I question if Tesco is positioned well to cope with rising inflation and muted consumer demand. And also, whether the current share price makes the FTSE 100 stock the perfect addition to my portfolio.
Inflation fears
Supermarkets have typically fared well in times of hardship. Food and drink are essential for human life and, as a result, there will always be a strong underlying demand for food retailers despite economic conditions. This was highlighted in the pandemic where the Tesco share price remained relatively unaffected while other stocks tumbled.
This being said, I believe soaring inflation is still a major threat for Tesco in the coming months. Customers will be forced to pull back their spending and they may shift towards lower-cost competitors such as Lidl and Aldi. Rising fuel and staffing costs will also put a strain on the company’s profit margins.
Being Britain’s biggest retailer means that ballooning wages will have a significant impact on Tesco’s finances. As the company employs around 300,000 individuals, raising the hourly wage by as little as 50p could add hundreds of millions to operating costs.
Robust results
Despite these inflation concerns, Tesco has had a good year. Pre-tax profit for the retailer rose to a healthy £2.033bn from £636m the year before. However, this high growth is likely influenced by poorer pandemic results.
The grocer has also increased its market share to an estimated 27.4% in the last year. This has been done by deepening customer relationships and incentivising brand loyalty through the expansion of Tesco’s Clubcard scheme. CEO Ken Murphy noted that Clubcard members are using discounted prices to fight against the costs of rising inflation. As a result, I believe the loyalty programme could help Tesco keep customers away from low-cost competitors.
A fair share price?
The Tesco share price is currently trading at a price-to-earnings (P/E) ratio of 13. While this is lower than the FTSE 100 average of 15, the company’s P/E ratio does sit slightly higher than direct competitor J Sainsbury’s 7.3 ratio. A further price decline would bring the Tesco P/E ratio more in line with the industry average.
The positive recent results and the growth in market share suggests to me that Tesco is positioned fairly well despite the upcoming challenges. This being said, I don’t believe that the Tesco share price has dropped enough for me to offset the upcoming risks that inflation provides. So, I am holding off from adding this FTSE 100 stock to my portfolio for the foreseeable future.
