Are Tesco (LSE: TSCO), Vodafone Group (LSE: VOD) and BAE Systems (LSE: BA) poised to deliver big gains?
In this article I’ll take a look at each stock and ask whether now is the time to buy.
Tesco
On the face of it, there’s no logical reason to buy or own shares in Tesco. The dividend has been cancelled, the shares trade on nearly 40 times 2015/16 forecast earnings and the firm’s £10bn net debt is far too high. Tesco’s asset backing is shaky, too. The current 188p share price is 2.5 times the firm’s 75p per share book price.
Given all of this, why haven’t Tesco shares fallen further, perhaps to as low as 100p?
Rightly or wrongly, the market is pricing in an eventual recovery for Tesco. It remains the UK’s largest supermarket, with a market share of around 28%. Total revenue this year is expected to be around £55bn. The City believes that Tesco can turnaround its business, and I tend to agree. Over a 3 to 5 year timescale, I expect Tesco to make a decent recovery.
However, I wouldn’t buy Tesco shares today, as I believe a lot of this potential recovery is already in the price.
Vodafone
Like Tesco, Vodafone appears to be priced to reflect the market’s expectation that profits will eventually recover. The big difference is that Vodafone offers an attractive 5.3% dividend yield and has a much stronger balance sheet.
Vodafone’s board has committed to maintain this dividend, but it’s not completely safe. Earnings are only expected to cover half the cost of the dividend between now and 2017, leaving Vodafone reliant on its reserves to fund the payout.
Vodafone’s profits should rise as spending on the Project Spring 3G/4G network upgrade programme tails off. There’s also evidence that European markets are starting to recover. The other possibility is that Vodafone will make a big acquisition to boost earnings.
I’m happy to hold, but if there’s no sign of progress next year, I may start to worry.
BAE Systems
BAE Systems ought to be a fairly safe share to hold. The firm’s biggest customers are governments in the UK, USA and Middle East. There doesn’t seem to be much chance that any of these countries will stop spending money on defence.
It’s not necessarily that simple though. BAE’s smaller UK peers, Chemring and Meggitt, have both fallen by around 20% over the last month after issuing profit warnings. The problem is that earnings visibility seems to be increasingly poor, and this could affect BAE.
Although the group’s order backlog of £37.3bn ought to be reassuring, short term earnings are less certain. BAE’s Australian ship-building business has run out of orders, and the order pipeline for Typhoon jets is also causing uncertainty. The firm warned earlier this year that earnings forecasts did depend on some “anticipated naval and aircraft orders”. I wouldn’t be surprised to see earnings slip a little this year.
BAE shares have fallen by 10% over the last six months. They now trade on 11.8 times forecast earnings, with a prospective yield of 4.7%. That seems fairly reasonable, but in my view, the shares aren’t quite the bargain they were a few years ago.