Why Tesco shares are a good buy

This top fund manager explains why investors shopping for bargain shares should be adding Tesco to their portfolio. 

Investors on the lookout for bargains may wish to consider adding Tesco to their portfolios, according to Alastair McKinnon, manager of Scottish Investment Trust.

This morning (15 June) Tesco announced a 10thconsecutive quarter of improved sales. Sales grew 1.8 per cent in the first quarter of 2018, compared to 1 per cent in same period last year, despite snow in Spring.

According to McKinnon, the results confirm that Tesco is on the turn. Scottish Investment Trust’s largest holding is Tesco, which makes up around 5 per cent of its portfolio.

‘Tesco’s come a long way,’ McKinnon notes. Around a decade ago, Tesco dramatically fell out of favour. ‘They took their eye off the core UK market’, says McKinnon. ‘

He adds: ‘They got too greedy. Their prices were too high just as start of recession.’ At the same time, the firm faced problems over accounting irregularities.

Tesco’s share price is still down by around 40 per cent from its peak in 2007.

McKinnon, however, thinks Tesco has strong future prospects, despite sitting in the crowded and competitive market that is UK retail. 

First of all, chief executive officer David Lewis and chief financial officer Alan Stuart have ‘restored Tesco’s reputation,’ he says. ‘Tesco is no longer a hated brand. They are back to being a cuddly brand. They are now competitive again,’ says McKinnon.

Reforms under the new leadership resulted in Tesco restoring its share dividend in October 2017.

McKinnon also believes popular concerns about the longevity of Tesco and other large retailers are overdone.

In recent years German discounters such as Aldi and Lidl have squeezed retailers like Tesco. However, McKinnon argues the trend towards German discounters is slowing.

He adds: ‘While they may continue to be an irritation, their success is a symptom of the economy rather than the result of being a better operator.’

The German discounters are somewhere consumers go when they are either time rich or tight for money, he notes. While offering cheaper products, they are also inconvenient. They often lack certain brands or items, forcing people to make two shopping trips.

‘As the economy improves, when people have a bit more money, they will prefer convenience of going to supermarkets, as long as prices are not that different,’ says McKinnon. ‘People don’t want to make two trips.’ At the same time, Tesco is now more competitive on price.

Nor does McKinnon see online disrupters as much of a threat. ‘A lot of people worry that supermarkets are vulnerable to an internet competitor,’ he says. ‘But Tesco is in a good position. It has a good online offering.’

He adds: ‘if anyone does enter this market, they will lose money for an awful long time. And having a lot of money isn’t a slam dunk. It would be quite irrational to enter. At this stage it’s still just a fear.’

The merger between Sainsbury’s and Asda should also benefit Tesco in the short-term. For the next year to 18 months, Sainsbury’s will be in limbo, says McKinnon. ‘While I’m sure that Sainsbury's will do a good job, it’s going take time. This gives Tesco time to restore its fortunes.’

Tesco is a ‘big stock that is still out of favour but clearly on recovery track,’ concludes McKinnon.

Other fund managers with a ‘value’ investment style are backing Tesco, including Alastair Mundy, manager of the Temple Bar investment trust. According to Mundy, compared to a couple of years ago Tesco is competing more successfully against the discounters.