Shares in grocery giant Tesco (LSE: TSCO) enjoyed a terrific start to 2015, the instalment of chief executive Dave Lewis last autumn coinciding with a steady improvement at the checkout. Investors took to the new man’s strategy of shuttering scores of underperforming stores, drastically cutting overheads — epitomised by the imminent closure of its Cheshunt HQ — and reducing the number of items on sale with great enthusiasm.
But the stock has slid lower again since the spring as the negative newsflow has resurfaced. Indeed, Tesco has skidded 25% lower from April’s heights to current levels around 187p, and recent Kantar Worldpanel numbers suggest that Lewis’ tenure is set to get a lot bumpier. Sales at the firm edged 0.9% lower during the 12 weeks to August 16th, the consultancy noted, driving Tesco’s market share to 28.3% from 28.8% a year ago.
Further weakness on the cards?
Despite Tesco’s recent heavy weakness, however, I still believe the embattled grocer remains shockingly overvalued. With sales expected to keep on tanking, the Hertfordshire firm is expected to see earnings slide 13% in the 12 months to February 2016, leaving a ridiculously-heady P/E rating of 22.5 times.
Not only does this lag fellow middle-ground straggler Morrisons, whose anticipated 8% decline leaves it on a earnings multiple of 16.5 times, but it also represents exceptionally poor value versus upmarket rival Sainsbury’s — the latter deals on a P/E rating of 11.7 times in line with an expected 19% bottom-line deterioration.
We are fast approaching the fourth anniversary of Tesco’s shock profit warning in 2012, but the firm is arguably in a worse state now thanks to the emergence of discounters like Aldi and Lidl. Given that deflation continues to rock revenues at Tesco, and customers continue to flock to its rivals, I would consider a P/E rating closer to the bargain benchmark of 10 times to be a fairer reflection of the grocer’s high-risk profile.
Consequently I believe Tesco should be dealing at just 81.7p per share, representing a mammoth 56% reduction from current levels.
Sales drivers under rising pressure
Sure, some would disagree with my assessment and point to Tesco’s dominance in the lucrative digital and convenience sectors. But as Kantar noted following its latest release: “buoyant growth in [Tesco’s] convenience stores and online has not been enough to offset lower revenues in the larger shops.”
And I expect conditions to become much more challenging looking ahead — the already-congested internet segment is becoming more and more competitive, exemplified by the rollout of Sainsbury’s ‘Brand Match’ promotion last month. And in the longer-term, the inevitable entry of Tesco’s low-price rivals in the online arena — Aldi has already started talking about selling wine via the internet — is likely to put Tesco’s ‘growth drivers’ under further stress.