Despite nearly doubling from 2022 lows, Tesco shares are still not expensive and present good value for the long-term holder.
Tesco’s share price chart is something to behold. Notwithstanding the obligatory bouts of profit-taking that produced drawdowns of no more than 20%, Tesco shares have been grinding nicely higher since touching 200p in October 2022.
Although shares dipped during the volatility in early August, it has been one-way traffic to the upside since, with only two down days since the beginning of August.
The relative safety of Tesco’s reliable cash flows has proved to be a draw for investors, not only during the recent spate of volatility but also throughout the interest rate hiking cycle and high levels of inflation.
Tesco has managed to pass on higher input costs through a careful pricing strategy, which saw group revenues grow 7.4% from FY23 to FY24 while operating margins grew 42bps to 4.2%. This was no mean feat, given that inflation ran hot for most of that period.
Subsequent evidence of strong leadership can be found in the successful navigation of easing inflation and the growth of Tesco’s market shares.
Sales grew 3.4% in the group’s first quarter as Tesco’s market shares grew 52bps to 27.6%. Tesco are locked into a bitter war of attrition on price with discounters Aldi and Lidl, which threatened Tesco’s market share as shoppers sought out value options amid the cost of living crisis.
However, the deployment budget ranges to rival the discounters have been a big success for Tesco and the mix of premium and budget options all under one roof has ensured market share gains and the maintenance of margins.
With pressures on households now easing with the cutting of interest rates, Tesco may see an opportunity in its Finest range, and households may find a little more cash in their pockets.
The positive environment for Tescos has been reflected in its share price, which is now up 26% year-to-date. However, this year’s gains don’t mean the stock hasn’t got further to run.
Tesco trades at 14.4x forward earnings. This isn’t particularly good value, but it’s certainly not expensive and doesn’t reflect the quality of the stock.
For a capital-intensive business such as Tesco, a Return on Capital Employed of 10 demonstrates its efficient operations. The 3.3% dividend yield is covered 1.9x by earnings, and Tesco is a cash-generating machine with free cash flow remaining in the $2bn range.
We wouldn’t suggest jumping straight into shares at current levels, but they are certainly one for the watchlist.