Tesco and Vodafone Yield 5%

STOCK UPDATE: Tesco has a new chief executive and Vodafone has done a deal with Portugal Telecom. Morningstar analysts review developments at these high yield stocks

Morningstar Equity Analysts 22 July, 2014 | 1:24PM
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Tesco – Yielding 5.3%

On July 21, Tesco (TSCO) announced that current chief executive Philip Clarke will be replaced by Dave Lewis, currently the president of Unilever’s personal care business, on October 1, 2014, writes Morningstar analyst Ken Perkins. This announcement follows the May announcement that Laurie McIlwee, currently the finance director at Tesco, will also leave in October. Lewis will join the board as Clarke steps down, but Clarke is expected to support the transition through the end of January 2015.

The announcement isn’t a complete surprise, as Tesco has struggled to rise above elevated competition in the U.K. over the past several trading periods. In the July 21 press release, management cautioned that results have been weaker than originally expected in early June, when the company issued its first-quarter interim sales update. Although Tesco has been justified in speaking of its solid omnichannel presence, price investments, and store renovations, the firm’s competitive strengths and strategic initiatives have yet to drive Tesco’s like-for-like sales growth and profits higher, and investors’ patience has run thin.

Although we intend to incorporate new information into our outlook, we don’t expect a material change to our £3.80 fair value estimate or our no-moat rating for Tesco. We expect U.K. like-for-like sales growth to remain muted and profit margins down this year due to elevated competition. Overall, we believe Tesco's shares are undervalued, but given the structural headwinds Tesco faces and the coming management transition, we think Tesco is suited only for investors with a long investment horizon and a high degree of risk tolerance.

Vodafone – Yielding 5.4%

On Monday, Vodafone (VOD) and Portugal Telecom announced an agreement to share a fibre network covering 900,000 homes, writes Morningstar analyst Allan C. Nichols. Each company will contribute 450,000 homes that already have fibre to the home built out, which will take PT's coverage to about 2.1 million homes, and Vodafone's to about 1.5 million. Vodafone plans to continue building its network out to reach about 2 million homes by the end of 2015. Both firms will develop their own marketing and pricing plans and compete for the same customers.

We're pleased to see Vodafone sign such a deal. We think it reduces the risk of the firm making another expensive acquisition of a cable operator in Portugal, as it has in Germany and Spain. This is another sign of the importance of convergence, where companies are increasingly selling bundles of services, including fixed-line and wireless telephony, broadband, and television. PT's MEO4 plan has been one of the most successful quad play offerings in the world where all four services are sold to the same customer. This deal will enhance both firms' ability to sell such products.

That said, we see this deal more as an acceleration of the network build-out process rather than any change of strategy that enhances both firm's ability to compete against the cable television operator. We are maintaining our fair value estimates and moat ratings for both companies. We continue to think Vodafone's shares are undervalued, and that PT's are fairly valued.

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.

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Morningstar Equity Analysts  Morningstar stock and fund analysts cover 2,000 mutual funds, 2,100 equities, and 300 exchange-traded funds.