Should I Buy Tesco?

Published in Company Comment on 8 October 2012

Harvey Jones sizes up Tesco (LSE: TSCO).

It's time to go shopping for shares again, but where to start? Mining giant Rio Tinto (LSE: RIO)? High-yielding insurer RSA Insurance Group (LSE: RSA)? Or renowned UK engineer Rolls-Royce (LSE: RR)?

There are plenty of great stocks to choose from, and I'm enjoying doing some window shopping. So here's the question I'm asking right now. Should I buy Tesco (LSE: TSCO)?

The big drop

Gosh, hasn't Tesco been a disappointment lately? A couple of years ago, this growth-hungry retail giant had gobbled up most of the UK high street and was sizing up the rest of the planet. It looked unstoppable.

But the world turned, and Tesco fell out of favour. UK shoppers bridled at its charmless big box stores. The supermarket's £500 million Big Price Drop campaign famously flopped. Sales fell for the first time since 1994.

In January, the unthinkable happened. Tesco's share price suffered its own Big Price Drop, plunging nearly 25% to from £4.11 to just £3.12 in a matter of days, wiping £5 billion off its market value. 

Just as shockingly, it has scarcely recovered since. You can now buy Tesco for £3.18. Does that make it a bargain?

A little help needed

It's a good time to find out, because Tesco has just posted its results for the half year to 26 August. And it's looking a bit shop-soiled, reporting a 12.4% fall in UK trading profits to £1.12bn, although it did return like-for-like sales growth for the first time in seven quarters, thanks to the success of its rebranded Everyday Value range. It was only a quarterly rise of 0.1% but, as they say, "every little helps".

Tesco also reported 11% growth in online UK sales, while chief executive Philip Clarke defended the profits drop by saying it had spent big this year, taking on 8,000 new staff and investing £1 billion in its stores, in a bid to boost the customer experience.

Mr Clarke also blamed the disappointing performance on rising fuel prices, tax hikes and slowing incomes, all of which have hit Tesco customers hard.

Mind you, they have also hit shoppers at Sainsbury's (LSE: SBRY), but sales growth has been stronger.

Think small

Investors who bought right after the big Tesco share price drop in January in the hope of making a quick profit will have to hunker down for a lengthy wait.

After years of sweeping all before it, Tesco has some adapting to do. It now plans to invest more in its online offerings, and slow its aggressive campaign to slap a new giant store on the edge of every UK city, town and village. Smaller stores are the future, it believes.

Tesco isn't just struggling in the UK. International profits fell 17% to £378 million, due to the slowing Chinese economy and eurozone austerity, where sales dropped nearly 7%.

This isn't an easy time to invest in retailers. Then again, the share price slump has left Tesco trading on a juicy yield of 4.5%, with a forecast price-to-earnings ratio of 9.8 for February 2013.

I like to buy big companies on bad news. Although I expect Tesco to struggle for a little longer, I wouldn't bet against it in the longer run. Over a five-year time frame, I'm tempted to gamble on its recovery.

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> Harvey doesn't hold any of the stocks mentioned in this article.

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Comments

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IDPickering 08 Oct 2012 , 9:55am

Good article Harvey, thanks.

I mentioned over on the HYP Practical Board that I was going to be buying some more Tesco in my HYP(ISA) here;

http://boards.fool.co.uk/tesco-are-in-the-frame-12655759.aspx

I'm confident, that with an at least five year investing horizon, as all investing should be IMHO, you can't go far wrong with picking up a slice of Tesco at these recent prices.

Ian.

BigJC1 08 Oct 2012 , 10:13am

Good article, Tesco is in a difficult position in the UK stuck between the low prices of Aldi and the upper ground of Sainsbury, Waitrose and M&S. With such a big market share it seems like the best it can do is tread water.

The great hope has been overseas expansion and long term this should position Tesco as a truly international brand which in turn must give it stronger foundations then those solely reliant on the UK. However, with all free cash going to shore up the under invested UK division will the long term international strategy splutter to a stop just when the huge Indian market is opening its doors ? One to buy and lock away for a few years whilst salting away the dividend.

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