The shares of Tesco (LSE: TSCO) trade around the level they first recorded at the end of 1997 and for most of 1998. Here are the main differences between now and then — and here is why Tesco stock could plunge to 100p.
Tesco 1998 vs Tesco 2015
In 1998, Tesco reported revenue of £17.7bn. That’s about one fourth of the turnover that Tesco is expected to report in 2015. The growth rate for revenue stood at 18.7% year on year. The food retail market was booming in those days, and Tesco had all it needed to strengthen its leadership ahead of Sainsbury’s.
Operating profit came in at £912m: it grew roughly in line with revenue, and was less than half the operating profit that Tesco is expected to report next year. In 1998, Tesco’s operating profit margin was about 1.5 percentage points above the level that Tesco is expected to report in 2015.
Between 1994 and 1998, Tesco’s market share grew from 10.7% to 15.2%. Tesco was smaller, better managed and more profitable. It also exploited favourable trends for the retail sector, which have continued for about 20 years until the departure of Terry Leahy.
Earnings And Price Target
In 1998, fully diluted earnings per share came in at 26.6p. They rose by 13.2% year on year. That’s in stark contrast with Tesco’s performance these days.
Not only is Tesco not growing right now, but its forward earnings per shares are expected to come in some 30% below the level they hit in 1998. The 1998 dividend stood at 11.6p: it was 80% higher than the dividend that Tesco is expected to pay next year.
A 45% discount to Tesco’s current stock price of 180p isn’t too aggressive under a base-case scenario, in my view. Although Tesco’s assets base indicates a fair value of between 200p and 250p a share, its stock price could easily drop to 100p, particularly if no-frills supermarkets continue to steal market share in the UK.
Divestment Premium: What Premium?
Tesco is big enough to fail. It owns valuable assets that will become less valuable as time goes by, in my view — unless, that is, radical action is taken.
According to several press reports, Tesco’s assets in Asia may fetch a valuation of £9bn, but such a price tag would imply a sales multiple of 0.85x, which is highly unlikely in this market. The shares of Tesco trade at roughly 0.3x sales.
There is no reason why any buyer would pay up for assets being held by a company that needs to raise cash at a time it struggles in its core markets. And there is no reason why Tesco could not bounce back, of course — but if you are on the hunt for value, you may well choose investments that offer much higher returns and lower risk in the current environment.