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Tesco’s shares offering excellent value for money

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While Tesco’s [LON:TSCO] share price has surged 9% higher since the start of the year, it continues to trade 14% down on its level from a year ago. Indeed, investor sentiment towards the firm remains weak even after it released a Christmas trading update earlier this month that showed it delivered strong growth and remains on track to meet full-year financial expectations.

Evidence of bearish market sentiment can be seen in the company’s valuation. It currently trades on a forward price-to-earnings ratio of around 11.5x at a time when the FTSE100 is flirting with an all-time high.


Of course, it is somewhat unsurprising that investors are downbeat about the firm’s prospects. Consumer confidence remains close to its lowest level since records began, while high inflation and rising interest rates are causing a cost-of-living crisis that is likely to have further to run. And with the UK widely expected to experience a recession this year, the company faces a challenging short-term operating outlook.

A sound business

However, Tesco is relatively well placed to overcome a tough period for the retail sector. Its dominant market position, evidenced through a 27.5% market share that has grown since the start of the pandemic, means it has size and scale that could enable it to better withstand squeezed margins compared with smaller rivals.

Its margins are set to be further supported by a cost reduction programme that is due to deliver GBP500m in efficiencies during the current year. This will take its total savings as part of a three-year programme to around GBP1bn by the end of 2024. It also has a solid financial position in an era of rapidly rising interest rates, with net finance costs covered around five times by operating profit in the most recent financial year.

Furthermore, the firm enjoys a significant degree of customer loyalty via the popularity of its Clubcard programme. It has over 20 million members who may be dissuaded from shopping elsewhere by the rewards they receive as part of the loyalty programme. And with Tesco having a net promoter score that is higher than any other full-line grocer, it is well placed to emerge from a cost-of-living crisis and extended period of weak consumer confidence in a stronger position than its rivals.

Investment potential

Trade TSCO on
Hargreaves Lansdown or IG
Over the coming years, Tesco’s share price is also set to be catalysed by a dominant online position that currently equates to a market share of around 36%. Although online sales as a proportion of total retail sales have moderated somewhat as Covid-19 restrictions have eased, digital grocery shopping nevertheless remains a key growth area across the industry.

Given the firm’s solid market position, capacity to overcome short-term threats and long-term growth prospects, its valuation appears to underestimate its investment potential. Certainly, further short-term share price volatility is likely given the challenging outlook for the retail sector and wider economy. But with the stock offering a wide margin of safety, now could be an opportune moment to invest on a long-term view.

Tesco opened the week’s trading (23rd January) at 248.8p. The retailer has offered a year-to-date return of 10.8%, a one-year return of -14% and its shares have ranged between 194.4p and 304.1p over a 52-week period, giving the company a market capitalisation of GBP18.2bn.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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