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Tesco - the good and bad news is that it is over the hump

By Chris Bailey | Wednesday 3 October 2018

Disclosure: I own shares in one or more of the stocks mentioned. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

Aside from a couple of brief comments on its new discount offering Jack's, the last time I wrote substantially on Tesco (TSCO) was six months ago - when I concluded that there was another leg in the share price to come, which duly resulted. But the wheels have come off the shares in the last couple of months. I still remain unconvinced by Jack's but in the wider scheme of things in the Tesco empire it is a rounding error. I think the real issue however is that Tesco is now no longer a recovery stock and - as we all know - it is easier to travel than arrive…

Today's half-year numbers look very solid at a number of levels, including an eleventh successive quarterly like-for-like sales increase and a 24% rise in UK profitability, even if Polish and Thai trading outside of the UK continue to have their issues. Meanwhile the Booker wholesale deal has bedded in well and key financial ratios have improved, moving the group even further away from the dog days of a few years ago.

The hiking of the interim dividend (+67%!) is testimony to all this, even if the company's dividend yield is still only in the range of 1.5-2%. Prospective comments about the future medium-term strategy remain unchanged and this means further progress in cost savings (£1.5 billion by 2019-20) and the bumping up of retail margin and improvement in debt metrics. If I screw my eyes up and work out some prospective numbers, then the stock is trading at a fairly attractive multiple assuming hitting those targets. Tesco back to being a 250p stock is not a huge stretch as the early summer share price showed.

The trouble is it is over the hump. Over 5,000 of the 10,000 Own Brand product re-launches have now occurred, the brand index it monitors is close to the average and internal staff measures of interaction and engagement have substantially improved. Well that is all good...but Mr Market always asks 'what is the next trick?'

And this question is probably at the heart of why the share is down 8% as I write. The big new initiative at the margin appears to be highlighting how competitive a basket of Tesco's goods are versus 'competitor A' and 'competitor L'. No prizes for guessing who it is talking about... This is not a price war per se, it is more about Tesco flexing its muscles again as the sector #1 who is not in recovery mode per se. Naturally that worries teenage scribbler analyst types...but they need to remember the food retail space is changing. The Asda/Sainsbury's deal is a big thing and will take capacity out and all of the current 'big 4' are working out how to play in a market with discounters and online delivery.

Tesco stock - as I write - is a bit too cheap and a fairer value today is a return (again) to that 240/250p level. Tesco is no longer on the ropes and is flexing its muscles. The difference with its heyday is that other players have bulked up a bit. That is why the share is not going back to the 4 quid price of 2010-11...but that does not mean it is uninteresting. I want to buy some more here.

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