It hasn’t been an easy decade in the life of Tesco (LSE: TSCO). Britain’s biggest retailer has been on the defensive as discounters like Aldi and Lidl and premium chains such as Waitrose have shorn down its customer base. The subsequent drive to slash prices has taken a huge bite out of profitability. And the problem is set to get worse as Amazon ramps up its attack both online and on the high street.
A report from consultancy Edge by Ascential showed that Amazon UK’s sales of edible products rocketed 17.6% year-on-year in 2020. Clearly, Covid-19 lockdowns have played into the hands of e-commerce retailers and this helped push the US company’s revenues to the moon. But the party isn’t over yet as consumer habits change and Amazon expands. Edge by Ascential thinks Amazon will be the 15th biggest seller of edible goods by 2025, up four places from today and overtaking the likes of Shell, McColl’s, BP and Wilko.
Tesco’s share price: ultra cheap on paper
It’s critical to remember that Tesco is still the UK’s biggest retailer. It has the financial clout, as well as the expertise, to remain a significant player in the grocery sector. And its acquisition of wholesaler Booker a few years ago offers plenty of promise too, as people spend more and more on going out instead of on physical goods. The reopening of the hospitality sector following the pandemic should give profits here a welcome jolt. Like-for-like sales at Booker leapt 9.2% during the three months to May.
Tesco’s share price looks very cheap on paper. City analysts think the retailer’s annual earnings will rocket 144% this fiscal year (to February 2022). Consequently the company trades on a forward price-to-earnings growth (PEG) ratio of just 0.1. A reading below 1 suggests that a stock could be undervalued by the market. The kicker is that Tesco also boasts a 4% dividend yield right now. This beats the broader FTSE 100 figure by almost a full percentage point.
A high-risk FTSE 100 stock
But in my opinion, this cheapness reflects Tesco’s uncertain position in a market that is becoming increasingly competitive and thus exerting more and more pressure on the supermarket’s ultra-thin margins. In the last non-coronavirus-affected fiscal year (to February 2020) the grocer’s operating margin in the UK and Ireland clocked in at a lowly 4.2%.
Tesco’s margins also face a significant threat from a shortage of lorry drivers, a problem that’s forced it to introduce £1,000 ‘golden hellos’ to HGV drivers in recent weeks. Rising employee costs threatens to be a long-term headache as well. Brexit has lowered the number of workers Tesco can call upon to keep its shelves stacked and lorries moving. A long fight against Covid-19 could worsen the problem too should travel restrictions remain in place. All things considered I’d rather buy other shares this August.