News that rating agency Moody’s has cut the rating on Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) bonds hasn’t changed my view on the supermarket: the likelihood of this downgrade was flagged up some time ago, and was already in the price, in my view.
Indeed, I believe that part of the reason Tesco is so unpopular with investors is because we know so much about it: as regular users of UK supermarkets, most Tesco investors have strong, emotional opinions on their strengths and weaknesses.
The problem is that emotion doesn’t make a good investment partner. In this article, I’d ask you to forget your opinions on Tesco, and focus on the numbers. Are they a buy?
1. 29%
Tesco still has a 29% share of the UK market, despite falling sales. Lidl and Aldi — the two firms said to be most responsible for Tesco’s declining sales — only have a combined market share of 8.3%. That’s less than one-third of Tesco’s 29% market share.
This is important: it’s obvious that Aldi and Lidl can’t expand to pose a serious threat to the big four supermarkets without vast capital expenditure on infrastructure and new stores. It simply won’t happen.
What’s more, Tesco is still profitable. Last year, the UK’s largest supermarket reported an industry-leading trading margin of 5.2%, while underlying profits fell by just 6.9% to £3.1bn — hardly a disaster.
2. 181p per share
Tesco’s appeal is also reflected in its valuation. Although 18 of 21 City analysts monitored by Reuters rate Tesco as a ‘hold’ or a ‘sell’, their consensus forecasts are for earnings of 26.4p per share this year, putting Tesco’s shares on an undemanding forecast P/E of 10.9.
Prospective dividend yield is also strong, at 4.8%, while Tesco’s £25.7bn property portfolio continues to provide attractive asset backing for the business, with a value of 317p per share.
Once Tesco’s debt is factored in, its overall net asset value per share is 181p, meaning that you are only risking around 110p per share for a retail business with annual profits of about 26p per share. That doesn’t seem like a big risk, to me.
3. 45%
Despite my obvious bullishness on Tesco, I’m not blind to its problems. Net gearing of around 45% is slightly higher than I’d like to see, and adjusted earnings have fallen for two consecutive years.
These trends need to reverse, but I believe Tesco’s current position is far stronger than market opinion would suggest.