Bullish: Alan Oscroft
What was it that cemented my bullish opinion towards Tesco (LSE: TSCO)? It was the pandemic, that’s what it was. It’s when things get tough that the biggest and best in the business shine. And shine is exactly what Tesco has done throughout the crisis.
At the interim stage, reported on 6 October, we saw revenue up, profit up, cash flow up, and debt down. Isn’t it great to see a healthy balance sheet these days? The dividend was maintained in line with policy, with any increase expected to come at full-year time. Tesco reiterated its “aim to grow the dividend per share each year.”
Through the worst of the pandemic, Tesco doubled its online delivery capacity to 1.5 million slots per week. And I rate that as one of its biggest strengths. Of all those new customers enjoying the home deliveries convenience, how many will prefer to trek to Aldi or Lidl now?
I see another major strength too, which is especially important today. In its first-half update, Tesco spoke of “the resilience of our supply chain and the depth of our supplier partnerships.” That’s key.
With a retail free cash flow target of between £1.4bn and £1.8bn per year, Tesco is ahead of the game. And I think it has the expertise, the infrastructure, and the management to remain there.
My only big question is, why haven’t I bought any yet? It’s simply because I’m always drawn to something else instead. But Tesco is very much on my buy list.
Alan Oscroft has no position in Tesco.
Bearish: Roland Head
The UK’s largest supermarket appears to be a well-run business that’s firing on all cylinders. So why am I bearish on Tesco?
In short, I think Tesco faces a mix of rising costs and low growth that’s likely to limit shareholder returns.
Let’s start with people. Tesco is one of the UK’s largest employers, with more than 360,000 staff. Many of these are paid rates just above the current minimum wage. I think it’s fair to assume that planned increases to national insurance and the minimum wage are likely to increase Tesco’s staffing costs.
Costs are rising in other areas too, including energy, raw materials, and transportation. Tesco needs to stay competitive with discounters Aldi and Lidl, so raising prices won’t necessarily be an easy option. Profit margins could come under pressure.
Growth opportunities may also be limited. In the past, Tesco might have opened new stores to boost profits. But the market is more competitive these days. Tesco already has a 28% market share. I don’t think there’s too much room for expansion.
City analysts covering the stock seem to agree. Their forecasts suggest the group’s sales will rise by just 1% next year. Pre-tax profit is expected to be flat.
I still think Tesco is a decent business. But the shares have risen by 30% over the last year and now trade on 13 times forecast earnings. The dividend yield has fallen to just 3.6%. For a mature business, that seems expensive enough to me. I’m not buying Tesco shares at the moment.
Roland Head has no position in Tesco.
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The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.