Tesco shares are still a buy say analysts despite battle for growth

Since May, Tesco’s share price (LSE: TSCO) has seen a notable decline of 9%, leaving the company with a substantial challenge to revive its earnings growth in an increasingly competitive market. Traditionally, the food retail …

Since May, Tesco’s share price (LSE: TSCO) has seen a notable decline of 9%, leaving the company with a substantial challenge to revive its earnings growth in an increasingly competitive market.

Traditionally, the food retail sector has provided a safe haven for investors during economic downturns. Tesco, however, finds itself in a challenging position despite its established presence. One of its key advantages lies in its exceptional delivery operation, which outperforms its rivals. With an impressive 1.1 million online orders recorded in the year leading up to March 2023, Tesco leads the way in e-revenues among grocers, surpassing even its closest competitor, Sainsbury’s.

The company recognises the tremendous revenue potential offered by its online division, especially as online grocery shopping catches up with the broader eCommerce market. Industry analysts at The Institute of Grocery Distribution anticipate a remarkable 22.6% surge in supermarkets’ internet revenues between 2022 and 2027, reaching a total of £5 billion. In order to fully exploit this vast opportunity, Tesco continues to make substantial investments. Last year, it opened two new urban fulfilment centres in Cambridge and Glasgow to meet future customer demands. Additionally, the popular Whoosh fast delivery service was rolled out to over 1,000 stores.

Despite these efforts, Tesco is confronted with intense competition within the UK grocery sector, both online and in-store. The pressure to reduce prices and maintain market share is mounting as rivals expand their operations. However, slashing prices comes at the expense of profits, as illustrated by last year’s results. Initiatives such as the “Aldi Price Match” and “Clubcard Prices” schemes caused a decline of over half a per cent in Tesco’s retail margins, resulting in a 6.9% drop in adjusted operating profit to £2.6 billion year on year.

Moreover, while Tesco continued to lower prices, its market share steadily eroded. In the financial year 2023, the company’s market share decreased by 39 basis points, reaching 27.3%. The rapid expansion of budget supermarket chains, Aldi and Lidl, poses a particular threat to Tesco’s future prospects. Lidl recently announced plans to hire an additional 1,500 staff for its warehouses and submitted a planning application for a new fulfilment centre in Leeds.

Furthermore, changes to loyalty schemes implemented by other grocery retailers, such as Sainsbury’s Nectar scheme and Morrisons’ new More Card, also pose a risk to Tesco’s earnings. The effectiveness of Tesco’s Clubcard money-off program, which has been a major draw for shoppers, may be impacted by these alterations as customers increasingly prioritise value.

Despite these challenges, signs of recovery in Tesco PLC shares could be on the cards, supported by an increase in UK consumers’ purchases of supermarket own-brand products. As the dominant player in the UK supermarket sector, with a market share of 27%, Tesco is well-positioned to benefit from a rebound in consumer spending if energy prices decrease as anticipated.

Although the current trading price stands at 26 times earnings, Tesco’s net income has demonstrated a recovery in recent quarters, with the added appeal of a solid 4% dividend. A focus on cost savings is expected to bolster margins in the short term, and there are hopes that the cost of living squeeze may alleviate in the second half of the year.

Additionally, the latest data from ONS revealed that grocery inflation in the UK fell from 17.8% to 17.2% in May, marking the second consecutive month of decrease. Comparatively, the UK’s inflation rate is the highest among Western European countries. High inflation poses a significant challenge for Tesco’s share price, exacerbating the headwinds faced by the company.

Analyst Consensus

Following the resignation of their chairman, Tesco shares have remained stable, indicating that the overall strategy of the company remains unaffected. Refinitiv data reveals a consensus analyst rating of “buy” for Tesco, with 3 strong buy ratings, 9 buy ratings, and 2 hold ratings. The median estimate suggests a long-term price target of 304.50 pence for the share, representing a potential increase of approximately 16% compared to the current price (as of 13 June 2023).

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