Searching for stylish clothes and investment research can go hand in hand, or so I’ve learned, and lately I’ve been spotting a decent amount of jewelery in Tesco’s F&F fashion range.
These findings have coincided with ‘buy’ recommendations for Tesco shares from investment banks Goldman Sachs, UBS and other big names, making me think this £19.35bn supermarket chain deserves a place in my briefcase.
Like Marks & Spencer, Tesco is re-emerging, a traditional player adapting to cater for those who shop online, but also those who like the convenience and social experience of shopping in a physical store.
To accelerate this evolution, Tesco can rely on its strengths in data and technology, making the most of not only its Clubcard loyalty card program but also its Dunnhumby analytics arm. Thanks to these operations, Chris Beckett, head of equity research at Quilter Cheviot, maintains that “the company is prepared to navigate changing competitive and market dynamics.”
Against this backdrop, US giant Morgan Stanley has rated Tesco as the top European retail stock, in a verdict that came ahead of Tesco’s £600m sale of its banking business to Barclays last week. Shore Capital’s Clive Black called the deal “an exceptional result.” He also rates Tesco a “buy”.
These positive valuations may provoke a critical response among long-term Tesco investors. The shares have risen 14 per cent in the last 12 months to 275p, as food price inflation has eased. However, they are still 32 per cent lower than at the beginning of 2014, when Tesco was embroiled in an accounting scandal, stemming from the revelation that profits had been overstated.
Such was the seriousness of the matter that it posed an existential threat to the 105-year-old company, it was investigated by the Serious Fraud Office and the Financial Conduct Authority.
However, the crisis did force the business to be remodeled. The mountain of debt was reduced and subsidiaries, such as the Harris & Hoole coffee shops, were sold.
Tesco’s willingness to sustain this transformation process is one of the reasons I will buy the shares.
“Tesco is now in the best position it has been in for more than a decade,” according to David Smith of Henderson High Income Trust, which has a stake in the supermarket. “It has strong commercial momentum and should be able to generate decent earnings growth.”
The deal to sell the bank should accelerate Tesco’s return to its core business.
Tesco has a 27.2 per cent share of the UK grocery market, almost double that of Sainsbury’s. It also has stores in the Czech Republic, Hungary and Slovakia, and owns the food wholesaler Booker.
But size is not Tesco’s only advantage. The German discounters Aldi and Lidl represent a constant challenge. However, two other major rivals are in disarray. Asda is struggling with substantial borrowings and debt is a huge challenge for Morrisons.
Meanwhile, Tesco is benefiting from its Aldi price match campaign which, tacitly, acknowledges that the discounter has become the industry’s price-setter.
Another stimulus for progress is discounts for Tesco’s 20 million Clubcard holders, although this two-tier pricing agreement is being investigated by the Competition and Markets Authority (CMA).
But Tesco doesn’t just focus on being cheap. Its Finest range responds to the ‘considered consumer’ trend, where shoppers spend cautiously but also indulge.
During the 19 weeks to January 6, there was a 17 per cent increase in sales of Finest products, one of the factors that allowed Tesco to have its best Christmas ever, with sales up 6.4 percent.
Announcing these figures, boss Ken Murphy said full-year profits were expected to be around £2.75bn, down from £2.6bn-£2.7bn. This should produce what he called “strong retail free cash flow generation of around £2bn”.
Free cash flow is the money left over after funding the maintenance of capital assets and paying expenses, which should ensure Tesco’s 4.1 per cent dividend yield is maintained.
For me, this performance is one of the most important reasons to invest some money in Tesco shares. The competitiveness of the food sector is such that its expansion is difficult.
Dividends – and share buybacks – have made Tesco a popular stock in UK equity funds such as City of London, Diverse Income, Edinburgh, Merchants and Witan.
In November 2022, I invested in M&S because I liked the clothes and the makeover. The results have been gratifying. I hope Tesco becomes equally popular with me.