Nearly four years on from when the company’s accounting scandal first broke in 2014, today Tesco is one of the most sought-after shares in the FTSE 100.
Year-to-date the stock has outperformed by around 19% excluding dividends, and over the past two years, shares in Tesco have returned a staggering 40%, compared to just 8% for the FTSE 100 excluding dividends.
The question I want to answer in this article is, is this performance justified, and is there still time to buy Tesco or should you sit back and wait for a better opportunity?
After adding 40% in 24 months, shares in Tesco look expensive, although not excessively so. Based on historical earnings, the stock is trading at a P/E of 22, which in my opinion is quite expensive for a low margin supermarket retailer.
However, City analysts have pencilled in earnings per share growth of 28% for fiscal 2019, and further growth of 20% for 2020. Based on these estimates, looking out to the end of the decade, the shares seem to be appropriately priced, trading at a 2020 P/E of 14.2.
That being said, there is a lot that can go wrong between now and 2020. Significant changes could derail the City’s view of the business.
Still, from what we know so far, the company looks as if it is sailing in the right direction. Tesco’s first quarter trading update, for the 30 weeks to the end of May 2018, showed group like-for-like sales growth of 1.8%. Like-for-like sales in the combined UK & ROI business grew by 3.5% mainly thanks to the integration of Booker, which started at the beginning of March. For the period, the Booker business produced like-for-like sales growth of 14.3%.
Management hopes that the integration of Booker will yield £200m in cost savings. To help boost profit margins, Tesco is also pursuing an agreement with French retailer Carrefour whereby the two companies will use their size to draw better prices from customers. These efforts are all part of management’s goal to increase the group’s operating margin to 4% in the near-term, up from around 3% at present. The City’s profit estimates are based on the company hitting these targets. Considering the quick turnaround Tesco has achieved since 2014, I’m of the view it can meet this goal.
Beware the high price
Having said all of the above, investors do need to be careful because at the current level, there is a lot of optimism baked into the Tesco share price. If growth falters, the stock could stumble.
With this being the case, personally, I’d want to wait for a better entry price before buying into the growth story. The merger of Sainsbury’s and ASDA, if it goes ahead, could put significant pressure on the business and unleash another vicious price war. Such a war could derail Tesco’s recovery plans.
Disclosure: The author owns no stock mentioned.