Interactive Investor

Are Tesco shares in the ‘bargain’ basket?

After a tough summer, a City firm thinks Tesco shares are at ‘a very attractive entry point’ as attention turns to half-year results in a few weeks’ time.

22nd August 2023 15:27

by Graeme Evans from interactive investor

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Tesco store 600

Tesco (LSE:TSCO) shares have been described as “intriguingly cheap” after a City bank reiterated its “buy” recommendation and upgraded earnings forecasts.

The UK’s largest grocer has seen a 14% pullback for its shares since May as industry pricing has come under greater scrutiny from regulators and in the press.

However, UBS believes these pressures should begin to fade amid growing recognition that the market is functioning competitively and not profiteering.

A price target of 300p compares with this afternoon’s 251.4p, with the bank seeing “a very attractive entry point” at a multiple of 11 times forward earnings.

UBS said half-year results on 4 October should pivot investor attention away from deflation concerns and back to the company’s record of strong trading and potential for upgrades.

It added: “We believe Tesco’s momentum and execution in a very rational UK industry points to strong profit growth in the first half.”

UBS’s latest estimates include 11% growth in underlying earnings to £1.38 billion for the first six months of the financial year, driven by second quarter like-for-like sales growth of 8% at both the core UK estate and cash-and-carry business Booker.

The bank’s analysis of leading consumer survey metrics show that Tesco has held on to the improvements it has made on price perception in recent years.

It also pointed to the Competition and Markets Authority’s recent review of cost of living pressures in the grocery market and comments in the Bank of England August inflation report as examples that suggest “scrutiny of the industry is likely to become less noticeable”. 

UBS believes Tesco is in a position to upgrade its outlook, although before doing so it will need to have improved visibility on consumer spending.

The bank’s own full-year estimate for underlying earnings of £2.62 billion is comfortably ahead of Tesco’s current guidance, with free cash flow at the top end of the company’s £1.4 billion-£1.8 billion range.

UBS said: “The first half should pivot investor focus to these upgrades away from the deflation thesis as we believe Tesco remains in a vastly different and a much stronger place versus history, helping it continue delivering into 2024-25.”

Founded in 1919, Tesco began as a market stall in the East End of London. Today, the company operates more than 4,800 stores in the UK, Ireland, Czech Republic, Slovakia and Hungary.

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