The turnaround at the UK’s largest supermarket giant Tesco (LSE: TSCO), is well under way. A trading update issued by the firm last week saw the group report positive like-for-like sales growth for a 10th straight quarter.
For the first quarter ending May 26, group like-for-like sales growth accelerated to 1.8% compared to 1% in the first quarter last year. At home, growth was even more impressive with UK & ROI like-for-like sales growth coming in at 3.5%, compared to 2.2% a year prior.
The fastest growing part of the business is now the Booker wholesale division, which Tesco acquired last year after a lengthy regulatory review. According to the recent trading update, Booker’s wholesale business delivered like-for-like sales growth of 14.3% including tobacco for the quarter ending May 26.
Following the publication of these numbers, shares in Tesco leapt to a new 52-week high of 254p on Friday morning, marking the first time the stock has traded above the critical 250p level since mid-2014 when accounting problems first emerged. And now the company has well and truly put these issues behind it, it looks to me as if the road to 400p is clear.
Boosting profits
It is difficult to argue that right now shares in Tesco look cheap. The stock is trading at a forward P/E of 17.7 based on current City estimates that the group will achieve 28% growth in earnings per share for fiscal 2019.
It is also difficult to get excited about the current dividend yield of 1.2%, although analysts believe this could hit 2.1% over the next 12 months.
However, while shares in Tesco might look expensive today, it’s the company’s future growth that gets me excited. By combining with Booker wholesale, the group has built an unrivalled distribution business across the UK. Tesco has identified a £2.5bn revenue growth “opportunity” from the tie-up and expects cost synergies to reach £200m each year by 2021.
Even though competition in the UK retail market remains cutthroat, and is only likely to increase following the merger of Sainsbury’s and ASDA, in my opinion, Tesco is well placed to outmanoeuvre its rivals.
Indeed, even though competition from the discounters Aldi and Lidl remains fierce, for the financial year to the end of February, the group chalked up an operating margin of 3%, 0.57% higher year-on-year and close to the company’s target of 4% by 2020.
A run to 400p
If the firm can hit management’s margin target, I believe the Tesco share price could make another run at 400p. Analysts have pencilled in a projected net profit for the group of £1.6bn for fiscal 2020 or 16.9p on a per share basis giving a 2020 P/E of 14.8.
The City is expecting this growth to continue on into the 2020s. Net income is projected to close in on £1.8bn for fiscal 2021, giving earnings per share of 18p and a P/E ratio of 13.9 based on the current price. As the stock is clearly in an uptrend at the moment, if Tesco can meet, or even beat this forecast, it is entirely possible the share price could make a run at 400p.