Tesco (LSE: TSCO) shares have fallen 17% in the last year. They’re cheaper than before but does that make them a bargain?
I was surprised to see that over five years, Tesco shares are actually up 25%. The collapse is quite recent, and we all know why. The cost-of-living crisis has driven up the cost of labour and goods, especially imports due to the weak pound, but supermarkets are struggling to pass the costs onto hard-pressed customers.
Tesco has had wafer-thin operating margins for years. Currently, they stand at 4.2%, but are forecast to narrow to 2.9%. Tesco posted revenues of £61.3bn in 2022 but its pre-tax profit was just £2bn. The UK’s number one grocer works hard for the money.
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The shares look cheap
Fighting this year’s consumer squeeze would be tough, but German discounters Aldi and Lidl are making it tougher. Last week, Lidl said it had taken £58m of spending from the big four supermarkets in a single month. Nearly 60% of us shop there and figures from Kantar show Lidl sales soaring 21.5% in a year, with Aldi up 22.7%.
Grocery inflation is now at a record 15% and one in four households are struggling as bills jump £682 in a year.
There is a good reason why Tesco shares trade at just 10.6 times earnings. Last month, it reported a 65% drop in half-year profits to £413m. Management said full-year retail adjusted operating profits would also slip, although they should still come in at between £2.4bn and £2.5bn.
That is surprisingly good, given the circumstances. Tesco also has a solid balance sheet. Net debt looks high at £10.5bn but that’s down from £13.2bn in 2019.
Given that today’s challenging conditions aren’t going to change any time soon, I don’t hold out too much hope of a sustainable rebound in the Tesco share price. The big attraction is the dividend, as the current yield is 4.7%, covered twice by earnings.
Still the one to beat
The payout looks sustainable. Tesco’s retail cash flow grew steadily from £889m in 2019 to £2.28bn in 2022. Last month, management lifted its interim dividend by 20%. It needs to keep investors happy somehow.
Tesco also has scale on its size. It remains by far the UK’s biggest grocer with 27% of the market, streaks ahead of Sainsbury’s at 14.9%, Kantar shows. Aldi and Lidl still have a long way to go, at 9.2% and 7.2% respectively.
Tesco has a loyal customer base and successful Clubcard scheme. Disposing of its operations in Asia and Poland has given the company more focus, although that’s a mixed blessing, given UK woes.
Earnings per share have jumped 89% from 11.58p in 2021 to 21.86p in 2022. I wouldn’t say Tesco shares are a raging bargain right now, given current troubles. However, I think the yield does make them a tempting buy for long-term investors like me.
I’ve bought a few FTSE 100 shares lately and don’t have the money to buy Tesco now. I’ll aim for the January sales. With luck it will be cheaper.
