MIDAS SHARE TIPS: Don’t shop for quick profit in Tesco shares

As Tesco so famously tells us, Every Little Helps, and the store’s beleaguered shareholders were hoping for at least a crumb of comfort from yesterday’s half-year results. 

The grocer tried to look on the bright side, with strong like-for-like sales and mostly maintained profits guidance for the full-year. However, the top end of this guidance – which gives analysts an idea of what to expect when it next reports – was trimmed modestly, sending shares spiralling to six-year lows. 

Like other retailers, Tesco is dealing with a long shopping list of problems, most of which are not of its own making. The cost of food is rising, and chief executive Ken Murphy says Tesco customers are ‘watching every penny’ to make ends meet. 

That means changing customer behaviour such as smaller basket sizes, more own-brand shopping and a Christmas more like Bob Cratchit’s than the traditional Bacchanalian feast. 

Tesco must adapt to this without losing share to discounters such as Aldi and Lidl, and this may mean tighter margins and lower profits. For example, it costs almost as much to deliver two smaller shops as one larger one, so while customers are cautious, Tesco’s costs rise. 

There is plenty of uncertainty on the horizon, too, something that the stock market absolutely hates. Murphy acknowledged that it is ‘too early to predict how customers will adapt’ to continuing price inflation. ‘Significant uncertainties in the external environment still exist, most notably how consumer behaviour continues to evolve,’ he warned. 

But while Tesco shares are in the bargain bin, there are still reasons to be cheerful, including a 20 per cent increase in the interim dividend. Analysts at Goldman Sachs described performance as ‘mixed’, with like-for-like sales ahead of expectations though profit margin was below expectations. 

William Woods, at Bernstein, likes the company’s new strategic framework focused on Value, Clubcard, Convenience and finding £1billion of cost savings over three years. The company is also returning cash to shareholders through a buyback. 

Woods described the plan as ‘a considered but potentially cautious framework, which we think is right given the challenges to the sector’. 

Clive Black, at Shore Capital, has a Hold rating on the stock, despite acknowledging a good first-half performance and the company’s high level of free cash flow and assets. 

He says he’s nervous due to inflation, as well as what he calls the ‘totally inept and incompetent British Government’, which is pushing up borrowing costs. 

‘Quite what the future holds for Tesco’s earnings remains to be seen, but uncertainty abounds,’ he warns.

MIDAS VERDICT: It’s hard not to feel sorry for Tesco’s Ken Murphy, who is doing everything right. He can’t be blamed for the increase in food inflation, problems with gilt yields, and the cost-of- living crisis, but his shareholders are reaping the consequences. 

Tesco’s shares have underperformed the broader grocery market in recent months, and we can expect further near-term weakness, as the problems that are affecting the business are not going to go away any time soon. 

On the bright side though, the company has plenty of cash, good relationships with suppliers and real expertise in offering value to customers when needed, so this is a storm it is likely to weather. 

Trading on a forward price earnings ratio of under ten times, with a 5 per cent dividend yield, Tesco’s expertise is likely to come good over the long term but it is only a buy for those who can wait it out.

Traded on: Main market Ticker: TSCO Contact: 01992 632222 or tesco.com