Tesco (LSE: TSCO) shares are a FTSE 100 shining light. They’ve been dazzling investors ever since Dave Lewis arrived as chief executive in October 2014 and kickstarted a much-needed recovery. The supermarket giant is now a standout blue-chip, with its shares up 96% over five years, before dividends.
Tesco operates in one of the most competitive sectors around, and has had to beat off the challenge from aggressive new entrants Aldi and Lidl, while battling rising costs, squeezed consumers and higher taxes on its army of 330,000 employees.
Yet it keeps delivering. So what’s the secret?
A brilliant FTSE 100 recovery
Lewis set about restoring trust with customers, suppliers and investors after a disastrous period. Successor Ken Murphy built on that work, keeping prices competitive while improving quality, service and availability.
Clubcard Prices and personalised offers encourage loyalty while giving Tesco valuable information about what customers buy. Its scale also gives it purchasing power and the ability to spread costs across a vast store network. That helps it compete with the discounters.
Tesco is finding new ways to reach customers rather than relying entirely on its traditional supermarkets. Sales through digital channels grew 8% in the first half, while rapid-delivery service Whoosh is expanding.
It’s not perfect. First-half results (8 October) showed a continued slide in sales at wholesale arm Booker, following the loss of a lower-margin national account and a continuing decline in tobacco sales.
Tesco’s margins are also wafer-thin by most industries’ standards. Its UK and Irish adjusted operating margin was just 5.1% in the first half. A small increase in costs can quickly eat into profits.
The October leap
I decided that this was as good as it would get for Tesco shares, only to watch them surge another 15% in October, boosted by those first-half results, which saw adjusted operating profit climb 6.5% to £1.78bn.
Management raised the lower end of its full-year profit forecast from £3bn to £3.15bn and increased its share buyback programme from £750m to £950m.
Is the price too high?
After their latest leap, Tesco shares trade on a toppy-looking price-to-earnings ratio of 18.3, while the dividend yield for new investors has slipped to 2.65%. It will do well to keep growing as winter looms and the squeeze on household finances looks set to tighten. If unemployment rises and shoppers become even more cautious, Tesco could find it harder to keep growing sales and profits.
This is a stunning company, brilliantly run, but I don’t think investors should consider buying at today’s elevated valuation. Of course, Tesco could prove me wrong, as it’s done before, but I’d rather sit tight and wait for a more attractive entry point. I wouldn’t suggest they consider selling though. Investing is a long-term game and on those terms, Tesco has done brilliantly.
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Harvey Jones does not hold any positions in the companies mentioned.
This story originally appeared on Motley Fool
