Would I really not buy Tesco (LSE: TSCO) shares at any price? Well, not literally not at any price — I mean, if you offered me yours for 50p apiece, I’d snap them up. What I mean is I wouldn’t buy them at any market price that seems likely any time soon. Why not?
Well, one thing is the current valuation. Even though the price has crashed by nearly 65% since the peak of October 2007, to around 190p, we’re still looking at a prospective P/E based on this year’s forecasts of 31. Sure, that’s with a further 35% fall in EPS expected, and the 60% rebound predicted for the year to February 2017 would drop the P/E to only 20.
That’s a growth valuation!
That’s still nearly 50% ahead of the FTSE 100 long-term average P/E of around 14, and the FTSE pays dividends of about 3% — but Tesco is expected to be yielding only around 1% in dividends by 2017. For a stock to be worth a premium valuation like that, especially on forecasts that are still 16 months out, a company needs to be ahead of its game — and Tesco obviously isn’t.
I’d say a fair P/E for Tesco is probably only around the 10 to 12 mark, so it needs to nearly double its EPS before I’d see it as worth a look — and then only if it manages to get its dividend back up around 3%.
And my real concerns are nothing to do with valuation. No, for me to be interested in examining a company’s valuation, I first have to be convinced that it’s a sound company whose fundamental performance — its sales, its profits, its margins — are all looking good, and I need confidence in the long-term abilities of its management.
Can they pull it off?
Now, I honestly don’t know whether CEO Dave Lewis and his management team are up to the task of turning things round — I’ve no reason to doubt them, and this month’s first-half report sounded positive with the fall in like-for-like sales flattening off. But the fact that I don’t know, and that until I see an actual return to profit growth I have no way of knowing, really turns me off.
In the marketplace, Tesco is still facing price deflation. I don’t see how it can win a price war against Lidl and Aldi, both of which still enjoy substantially lower costs than Tesco — and while Tesco is closing stores and selling them off, it seems like Lidl and Aldi are opening new ones almost every day. If a company can’t win on price, it needs to differentiate itself from the competition in some other way, and I don’t see it.
One area in which Tesco is still reasonably well ahead is in home shopping, but it’s up against Asda, J Sainsbury and Ocado (which is also behind Morrisons‘ offering), and there really is no differentiation at all between different companies’ home delivery experiences — you order your stuff, and it turns up in a van. And when, as surely they will, Lidl and Aldi start delivering groceries, differentiation will surely truly only be on price.
Just what company is it?
A problem with Tesco’s valuation today is that people still see it as the same company it used to be, back when it was increasingly entering more upmarket businesses, diversifying its interests, and expanding overseas. But that company no longer exists. It is gone.
And until I get to know what its replacement is going to look like and what sort of market share it’s likely to hang on to, and until I see some reliable like-for-like profit growth, I’m staying behind my bargepole.