While Tesco’s [TSCO] stock has some risk factors to consider – namely Brexit and international growth problems – it does boast a healthy dividend. 

The UK grocer has seen its interim dividend increase 67% in October to 1.67p per share and is forecast to pay out 5.14p for the year ending 24 February 2019. In addition, the stock now has a PEG ratio of just 0.8 and an earnings ratio of 17.

 

Dividend per share % change, H1 YoY+67%
Market cap£18.904bn
PE Ratio (TTM)17.34

Tesco stock vitals, Yahoo finance, as at 18 December 2018

 

Problems abroad discourage investors despite UK sales uplift

Despite Tesco reporting an increase of 2.3% in sales at £51bn, and a 2.8% increase in revenue at £57.5bn for its half-year performance, its shares fell by 9% after the announcement on 3 October, its worst performance since the aftermath of the Brexit referendum in 2016. 

The decline in share price was largely due to problems in Poland and Thailand, which caused the supermarket chain to miss half-year profit expectations, with its operating profit rising only 24% to £933m, compared to forecasts of £978m. 

9%

Tesco share price decline after their H1 earnings announcement, 3 October

Its merger with UK wholesale operator Booker in March, and alliance with French supermarket Carrefour [CA] in July, are expected to further the company’s strategic progress abroad, especially after Tesco’s failed expansion into France in the 1990s. 

Exane BNP Paribas believe that while Tesco can continue to rebuild profitability, market expectations are still too high, particularly for its Booker wholesale chain. “We think the market is still struggling to understand that for Booker, sales growth doesn’t always drive earnings growth,” it added. 

Before the sell-off over its half-year performance, the British multinational’s share price had reached a high of 266.20p in October, although since then it’s predominantly been on a downward trend, plummeting by as much as 25% from its peak. The company is expected to report third-quarter earnings on 10 January 2019.

 

Rising competition and Brexit’s looming impact

Like most UK stocks, Tesco has an uncertain outlook due to Brexit, especially as a cautious consumer trend settles in and the ambiguity surrounding a deal heightens. 

A massive concern for UK supermarkets is whether a tariff and currency-induced food-cost inflation will occur as a result of leaving the EU, especially after the Bank of England announced that higher levels of inflation may be necessary. 

In the meantime, Tesco is stockpiling food to fend off shortages if a no deal arises. CEO Dave Lewis said that ensuring uninterrupted food supply chains is the “single biggest challenge” facing supermarkets ahead of Brexit. 

Brexit is by far Tesco’s biggest hindrance, but it is also contending with the retail revolution as online sales, delivery and autonomous grocery services evolve. This has the potential to hurt sales and margin growth in the future.  

“Single biggest challenge” - Tesco CEO, Dave Lewis, on ensuring uninterrupted food supply chains

In addition, Tesco is also under pressure to keep its prices low due to increasing competition from discount stores, such as Aldi and Lidl, as well as the recently merged Sainsbury’s [SBRY] and Asda, the group’s largest competitors.

Discounters have continued to win market share throughout the year, as subdued industry growth settles in and the UK’s big four grocers contend with falling volumes. In an effort to stay competitive, Tesco launched its own discount chain called Jack’s, in September.

 

Firms hold positive sentiment  

For Exane BNP Paribas, their outlook for Tesco shares is positive as it’s one of the cheapest stocks in the grocery sector at 11 times earnings and 8% free cash flow yield. “Our biggest issue with Tesco’s shares has been the market’s expectation of earnings recovery and growth, rather than the ability of Tesco to improve,” it said in a note.

The possibility of a cash return in the next financial year has also been floated, with UBS going as far as to predict a £1.5bn share buyback to send a “strong signal and create shareholder value in a low-risk manner”.  

Although it may seem like the stock’s fate is tied to the outcome of Brexit, the company’s robust UK sales growth, its new discount store, growing expansion overseas, its focus on efficiency and improved product quality, are all good indicators of a sustainable long-term growth strategy. 

Looking ahead, CEO Lewis says that Tesco is “well-positioned to deliver strong, sustainable returns for shareholders”.