Tesco Outperforms, Shares Undervalued

Shares in Tesco are an attractive buying opportunity, say analysts, after the supermarket outpaced its rivals over Christmas

Ioannis Pontikis 10 January, 2019 | 2:44PM

Tesco

Tesco shares rose today after the UK's largest supermarket reported a 2.1% rise in sales for the 19 weeks to January 5, better than rivals' performance over the festive period and in line with Morningstar analyst expectations.

We were once again satisfied with Tesco's core business in the United Kingdom, which increased like-for-like sales at a healthy 2.2% rate and outperformed peers across all relevant categories: food, general merchandise, and clothing. This beats Morrisons' 0.6% like-for-like sales growth during Christmas and Sainsbury's 0.4% grocery like-for-like growth.

We think this outperformance is partly the result of a focused range architecture both in general merchandise – skewed towards products that are complementary to grocery shopping – as well as with the introduction of high quality/value store brands such as Exclusively at Tesco, which was purchased by more than 80% of Tesco's customers during the period.

We believe Tesco is the best-positioned big four grocer in the UK, given its channel exposure, scale, and strategic decision to grow in the dynamic wholesale market through its Booker acquisition. The latter continues to grow rapidly, with 10.7% and 8.2% like-for-like growth in the third quarter and Christmas period, respectively. 

Tesco Shares Below Fair Value

From its high of 266p on August 10, Tesco's share price has declined about 20%, erasing its sector-beating year-to-date return partly because of Brexit uncertainty, a fierce UK trading environment, a painful operational rebalancing of the Asian business, and profitability concerns in Poland, where Tesco is actively divesting stores. 

With shares at 214p at the time of writing, the stock is trading roughly 15% below our fair value estimate, an attractive buying opportunity, in our opinion. In the absence of any meaningful hard catalysts in the quarters and months ahead, we believe the stock's dividend growth potential should be appealing to the patient long-term investor. We expect dividends to grow at a 15% compound annual growth rate over the next five years, with the company reaching its target 50% payout ratio by the 2021 financial year.

We believe Tesco's core strengths are sourced primarily from its scale on food, which can leverage through its recently acquired Booker business into the high-growth and less competitive wholesale market (caterers and wholesale convenience). Booker's double-digit top-line growth since the integration is evidence of that potential, and we view this direction as the only way for Tesco to grow profitably in the U.K. and stand out from the pack.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Tesco PLC231.70 GBX-0.64

About Author

Ioannis Pontikis  is an Equity Analyst for Morningstar

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