Like million of others, I shop regularly at Tesco (LSE: TSCO). I’m kept loyal by its Clubcard programme and all-round value for money (relatively speaking for the UK). But I’ve never owned any of the supermarket’s dividend-paying shares that might help me generate a second income.
I see the Tesco share price has dropped 15% since mid-February. So, is this my chance to snap up the FTSE 100 dividend stock while it’s in the discount aisle? Let’s take a look.
What’s going on?
Over the past few years, Tesco has done a great job of navigating the challenges of high inflation. Its Finest range combined with the Aldi price-matching initiative has resulted in a strong product mix, luring in a diverse set of customers despite relentless competitive pressures.
Indeed, at the start of this year, the company had increased its market share to a commanding 28.3%. Meanwhile, Aldi and Lidl have continued to take market share, meaning supermarkets other than Tesco have been losing out.
Recently though, one of those (Asda) has vowed to fight back. It has initiated a price-cutting strategy to regain market share, backed by what it says is a “pretty significant war chest“.
The risk here then is that a price war could be brewing across the UK supermarket sector.
Profit pressure
In anticipation of this, Tesco dropped a profit warning on 10 April when it released its preliminary results for the full year ending February. It said adjusted operating profit for the current financial year would be £2.7bn to £3bn, down from £3.3bn last year.
In the last few months, we have seen a further increase in the competitive intensity of the UK market. We are committed to ensuring that customers get the best value in the market by shopping at Tesco and we see further opportunities to protect and strengthen our competitiveness.
Tesco, April 2025.
This isn’t disastrous, of course, and it committed to a £1.45bn share buyback over the next year. This will be funded by £750m in free cash flow and £700m from the sale of its banking operations. Meanwhile, free cash flow is expected to remain within medium-term guidance of £1.4bn to £1.8bn.
Nevertheless, the prospect of a price war between grocers doesn’t get me too excited about investing. Growth could be subdued for a while, even if Asda doesn’t make a dent in Tesco’s market-leading position.
Also, higher National Insurance contributions will cost £235m this year, forcing the group to cut costs to offset this.
Dividend yield
I fear all this might result in a drifting — or even lower — share price. To compensate for this risk then, I want a big juicy dividend yield.
But do I get that here? Well, the full-year dividend was 13.7p per share, which translates into a yield of about 4.1%, based on the current share price.
Unfortunately, that’s not too much higher than the FTSE 100 average of 3.6%.
My decision
I don’t think Tesco’s position is under threat, and I won’t be surprised if its operating profit comes in towards the higher end of the cautious guidance. It has massive scale, a powerful Clubcard scheme and growing Finest range, and a well-oiled delivery service.
However, the yield isn’t high enough to tempt me, given the weak growth outlook.
