Despite a 34% increase from its 12-month traded low of £2.68, Tesco’s (LSE: TSCO) share price still looks very undervalued to me.
On the key price-to-earnings ratio (P/E) stock valuation measurement it currently trades at 13. This is second from bottom of its publicly-traded peer group, which has an average P/E of 23.8.
The number is slightly skewed by J Sainsbury’s leading P/E of 49.5. However, only factoring in the other three – Marks and Spencer (at 17.3), Koninklijke Ahold Delhaize (16.5), and Carrefour (12) — gives an average of 15.3. This still leaves Tesco looking cheap.
To ascertain how cheap it is in cash terms, I ran a discounted cash flow analysis using other analysts’ figures and my own. This shows the stock to be 45% undervalued at its current £3.58 price.
Therefore, a fair value for the shares would be £6.51. They may go lower or higher than that, given the vagaries of the market, of course. But it underlines to me how much of a bargain the stock looks now.
Promising results for the future?
Tesco’s broad strategy remains a focus on price, quality and innovation. To this effect, H1 of its fiscal year 2024/25 saw it continue to lower prices on thousands of product lines. It also launched or improved more than 860 products in partnership with its suppliers and growers.
The result of these efforts was a 15.8% increase in adjusted operating profit compared to H1 2023/24 via a 4% rise in sales.
A key risk for Tesco is a resurgence in the cost-of-living crisis that could reduce regular customer spend.
However, following the H1 results, Tesco expects around a £2.9bn retail adjusted operating profit for the full 2024/25 fiscal year. This compares to £2.8bn last year. It also maintains its forecast that it will generate £1.4bn-£1.8bn of retail free cash flow over the medium term.
Consensus analysts’ estimates are that its return on equity will reach 16.6% by end-2027.
Will I buy the stock?
My portfolio is constructed to generate as much dividend income as possible as I am over 50 now. This should enable me to continue to reduce my working commitments without damaging my overall financial position.
Tesco’s dividend last year was 12.1p, which yields 3.4% on its current share price. This is around the 3.5% present average return of the FTSE 100 and more than the 3.3% the FTSE 250 offers. But it is way off the near-9% average that my high-yield shares generate.
That said, if I were even 10 years younger, I would seriously consider buying Tesco shares. In its H1 results it increased its interim dividend by 10.4% to 4.25p from 3.85p. If this rise were applied to last year’s total 12.1p dividend, then the full payout this year would be 13.4p.
And analysts forecast that the total payouts in 2025/26 and 2026/27 will be 14.2p and 15.3p, respectively. These would generate yields of 4% and 4.3% based on the current share price.
Additionally positive for shareholders is that the grocer is on track to complete its ongoing £1bn buyback by April 2025. These tend to support share price gains.
