The Tesco (LSE:TSCO) share price has rallied hard. It’s up 24% since January and is now changing hands at £3.64 — a level last seen over a decade ago.
As a shareholder, I’m pleased. It feels like the FTSE 100 supermarket’s finally realising its true growth potential. Plus, let’s not forget the handy 3.3% dividend yield that boosts the overall return.
Let’s look at why Tesco shares have been climbing and where they could go next.
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Every little helps
There’s no single primary cause underpinning Tesco’s share price gains. Rather, several factors are collectively contributing to the company’s success.
According to Kantar, the UK’s largest supermarket has expanded its market share every month over the past year. Tesco now claims a whopping 27.6% of the British grocery market.
This is an encouraging data point. The rise of rival discount supermarket chains like Aldi and Lidl is a key risk facing the firm. Tesco’s rising to the challenge.
In addition, the business is advancing a share buyback programme to raise shareholder value. This year it committed to purchase an additional £1bn by April 2025. The cumulative total will reach £2.8bn since the programme started in October 2021.
Tesco’s also seeking to harness artificial intelligence (AI) to personalise customers’ shopping experiences. The company plans to use its data on 22m UK households that own a Tesco Clubcard.
Ultimately, this move could be highly beneficial for retaining existing customers and attracting new ones. AI technology can help consumers make healthier choices, reduce waste and, most importantly, cut their shopping bills.
Still reasonably valued
Despite the recent rally, I don’t think Tesco shares are expensive yet. A forward price-to-earnings (P/E) ratio of 13.3 might not be bargain basement territory, but equally, the stock doesn’t look overvalued.
For context, FTSE 100 competitor Sainsbury’s is in a similar ballpark with a forward P/E of 11.3. Likewise, Tesco’s price-to-sales (P/S) ratio of 0.39 isn’t wildly higher than the 0.22 multiple for Sainsbury’s.
The remaining duo from Britain’s ‘Big Four’ supermarkets are ASDA and Morrisons. Both are under private equity ownership. Burdened by debt and losing market share, they’re struggling to mount a successful threat to Tesco’s leading position.
With this in mind, I think Tesco shares deserve to trade at a slight premium.
Risks
That doesn’t mean it’s a risk-free stock. While Tesco’s holding its own for now, challenges from competitors — especially the German discounters — shouldn’t be ignored. After all, it’s a cutthroat sector with thin margins.
Rising labour costs could prove to be a thorn in Tesco’s side too, putting pressure on profits. The company recently lost a Supreme Court case against the Usdaw union over so-called ‘fire and re-hire’ practices for staff at its distribution centres.
In addition, the new government’s Employment Rights Bill will be tabled in Parliament next month. It’s worth monitoring developments to gauge the extent of any new obligations on Tesco.
I’m holding my shares
Overall, I believe the investment case for Tesco remains compelling. Successfully retaining its dominant position, the supermarket continues to benefit from economies of scale that its competitors don’t have.
With further share price growth potential and a healthy dose of passive income on offer, I’ll remain a Tesco shareholder for the long term.
