Could Tesco PLC Be The Ideal Value Investment?

Tesco PLC’s (LON: TSCO) share price performance is poor, but you might be able to take advantage of the market’s pessimism.

Mark Stones

Mark Stones (TMFMumbojumbones) joined The Motley Fool in 2014 and initially worked as a writer for Fool.co.uk, before joining the Fool’s analyst programme. Mark earned a BA in English from Loughborough University. Although he spends more time reading annual reports than Russian literature these days, he still appreciates a novelist’s antipathy toward the accepted view, which is a useful attitude when trying to sniff out hidden gems on the stock market. His approach to investing has been largely influenced by the principles of Warren Buffett and Peter Lynch. He also takes a special interest in the work of healthcare companies. Outside of investing, Mark plays guitar, enjoys good writing and has a guilty passion for combat sports.

Published 23 April, 2014 10:23 am BST

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The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

You might wonder how, when Tesco’s (LSE: TSCO) shares have lost nearly 25% in the span of a single year, you could construct a reasoned case that this actually is a stock you should own. It seems a little counterintuitive on the face of it.

But to think as such, “why buy a crummy share that’s lost value?”, is to confuse the market price with the quality of the business. There’s frequently no link between the two — at least in the short term.

Taking a longer-term position should ensure that in time your investment realises its fundamental value. Rather, leave the speculators to guess what the market price is going to do next.

As investors, price fluctuations serve one main purpose — to enable us to buy when prices are cheap and, should you choose, sell at a tidy profit.

If you buy and hold Tesco for three, four or five years, what kind of return can you expect?

Tesco’s 2014 results gave us a few clues.

Banking on a turnaround

The headline number was 6%. That was the amount profit declined. But the market had braced itself for much worse, and as a result the shares actually gained 4%. For a canny value investor, this might seem unfortunate, but there’s no way to perfectly time each and every trade and, in the long run, paying a little bit extra isn’t a disaster.

More alarming is the 3% decline in like-for-like sales, although on the bright side Tesco’s industry-leading margins provide scope to manoeuvre. Having adhered to maintaining margins at the expense of sales for many years, the retailer has finally abandoned margin targets.

What this means is that £200m in price cuts since February, on products like milk, eggs and butter could be, in the words of Tesco boss Philip Clarke, “just the start”. Of course, customers have to bite. There’s deep mistrust that, if price cuts are offset by increasing the cost of other goods, then they’ll be no better off. Marketing will have to convince shoppers this isn’t a ruse.

Positively, online sales grew 11%. There are now 1,750 Click & Collect locations that enable customers to receive free next day deliveries. Tesco has the scale — the warehouses and logistics — to enable it to reign supreme in the online arena. This is a fight I’m confident Tesco can win, which bodes well for the future as the worlds of online and offline retailing converge.