After around five years of restructuring its operations, I think now is finally the time to be greedy with the Tesco (LSE: TSCO) share price, as it reaches the end of its transformation programme.
There are several reasons why I’m so optimistic about the outlook for the UK’s largest retailer right now. For a start, the enterprise is finally back to where it was in 2014 before the accounting scandal broke and a new management team had to be bought in to restore confidence in the business and improve the customer experience.
As part of this turnaround, the company’s loss ballooned to nearly £6bn in 2015. City analysts believe Tesco’s net profit will come in at £1.7bn for fiscal 2020, rising to £1.8bn for fiscal 2021. That’s nearly double the £974m net profit figure reported for 2014, before the accounting scandal broke.
And as profits have recovered, management has been quick to reinstate the firm’s dividend. In 2019, Tesco paid out 5.8p per share in dividends to investors, giving a dividend yield of 2.6% on the current share price. City analysts believe the company will hike its distribution to 8.3p for 2020 and 9.2p for 2021, giving a potential dividend yield of 4.1% on the current share price for the 2021 fiscal year.
These numbers suggest that after a five-year break, Tesco has finally recovered its crown as an FTSE 100 income investment.
As well as Tesco’s profit recovery, I’m also impressed by how the group has been able to consolidate its position as the UK’s largest retailer over the past half-decade.
The acquisition of wholesaler Booker several years ago gave the company a unique position in the wholesale market, as well as improving its negotiating position with suppliers. This is one of the reasons why the group’s profits have surged in the past two years.
What’s more, it’s going to be much harder for competitors to unseat Tesco from its position at the top of the market now it owns a much more significant market share. The German discounters are still expanding aggressively across the UK but, despite this threat, Tesco’s bottom line is still set to increase.
The third and final reason why I think now could be a great time to be greedy with the Tesco share price is the stock’s current valuation. At the time of writing, shares in the retailer are dealing at a forward P/E of 13.4, falling to 12.4 for fiscal 2021.
I would say this valuation is about appropriate for the business, although I think there’s also an excellent argument to be made that these multiples undervalue the group, considering its size and dominance of the UK retail market.
The rest of the UK retail industry is dealing at a median P/E of around 12.5, and I think Tesco certainly deserves a premium over this average.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019