Tesco restores dividend: are the shares a buy?

Tesco has returned to the dividend register, three years after it took an axe to its income payments.

The supermarket’s return to paying a dividend comes after its pre-tax profits for the year rose to £562 million while sales growth continued to climb.

Under the leadership of its CEO David Lewis, Tesco has now seen its seventh consecutive quarter of sales growth recovery. UK like-for-like sales have increased by 2.1 per cent while overall group sales rose 3.3 per cent.

Pre-tax profits for the company rose to £562m this year, up from £71m one year ago – an increase of 667 per cent.

On the back of this, the supermarket giant has decided to start paying shareholders an interim dividend of 1p per share.

A darling of income investors in the 2000s, in recent years Tesco has been marred by an accounting scandal and poor performance. In a recent court hearing, it was alleged that former executives at the company had pressured senior staff to ‘misreport’ profits to hide the company’s financial troubles.

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Since his appointment as CEO three years ago, Lewis has pursued aggressive cost-cutting measures in attempt to turn the grocer’s fortunes around.

Over the past year, Tesco has particularly benefited from being more reluctant than its rivals to raise prices in the face of import-inflation. Tesco had the lowest level of food price inflation among peers.

In a statement, Lewis, said: ‘We are continuing to make strong progress. Sales are up, profits are up, cash generation continues to strengthen and net debt levels are less than half what they were when we started our turnaround three years ago.’

Should investors buy?

Dividend pay-outs were initially planned to be introduced in 2018, so the early introduction of an interim dividend could be read as sign that Tesco is on the path to recovery. 

As Ed Meier, manager of Old Mutual UK Equity Income Fund noted: ‘We have, for a long time, liked the prospects of Tesco’s new strategy under CEO Dave Lewis which he says this morning is “firmly on track” to deliver. These results give confidence in underlying potential for earnings, cashflow and, yes, dividends.’

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However, according to Mike van Dulken, head of research at Accendo Markets, investors should still be cautious. While the dividend pay-outs can be taken as ‘evidence of management faith in the turnaround and recovery,’ he notes that ‘it does nothing to hide what is worryingly pedestrian UK Q2 growth of just 0.4 per cent for transactions and 0.3 per cent for volumes while like-for-like sales slow to 2.1 per cent from what may now prove a brief 2.3 per cent peak in Q1.’

At the same time, Tesco‘s market position continues to be threatened by the rise of discount competitors: ‘Aldi and Lidl continue to take market share monthly, openly competing on price (now 12.2 per cent combined market share, +3.9pts since Jan 2015, vs TSCO’s 27.8 per cent, -1.3pts since Jan 2015).’

Helal Miah investment research analyst at The Share Centre made a similar point, noting that ‘while the numbers and story behind Tesco at the moment looks encouraging,’ it should be remembered that ‘competition is here to stay and will be ramped up by the German discounters making the margin improvement targets more difficult to achieve over time.’

In Miah’s view, Tesco shares should be seen as a ‘hold’ for medium risk investors.

Killik & Co, however, are more bearish. In a broker note, they pointed out that despite Tesco’s recent strong performance ‘there remains a significant level of uncertainty surrounding the medium-term outlook for Tesco.’

It added: ‘We believe that the UK supermarket sector is largely un-investable, given high competition between the big players, and the threat from rapidly-expanding discounters.’

At the same time, the wealth manager noted, Tesco shares appear expensive with a 19.6x price to earnings ratio based on their February 2018 consensus earnings – much higher than historical averages and market peers. According to Killik, Tesco shares remain a ‘sell’. 

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