Should I buy shares in Tesco?

During a reasonably busy day on the markets on Thursday 12 January the one name that kept coming up was Tesco.

The supermarket's shares sank more than 10 per cent within the first couple of hours of trading and continued to head south throughout the day, closing a fraction under 16 per cent lower at 322p.

But as the stock was precipitated by gloomy trading numbers and a profit warning, the question of a distinct lack of bargain hunters was being discussed as much as the fall from grace itself.

Mike McCudden, head of retail derivatives at our sister website Interactive Investor, warned that Morrisons and Sainsbury's will smell blood.

'Tesco's strategy to simply slash prices has backfired as the UK consumers reign in their spending habits. They will require significant investment as customers demand service akin to John Lewis but at rock bottom prices. With margins already tight, this will be a long slog as they attempt to regroup and rein in plans for further overseas expansion,' he noted.

'I think the decline was quite a surprising one, particularly that it stayed so weak into the close, I too would have thought we would have seen a few bargain hunters out after the initial fall,' said David Jones, chief market strategist at IG Index.

He believes the plunging price is a rare event and feels overdone, but ponders whether the abundance of subsequent navel-gazing signals the end of the growth story for the nation's omnipresent supermarket.

'I think because we have all got so used to steady growth year in and out from Tesco with no surprises, many investors were shell-shocked by today's news,' Jones told Interactive Investor.

He points out that with the cheaper price making the yield for longer-term potential buyers even more attractive, it's an interesting one to watch over the next couple of days. 'If we see the price start to stabilise it wouldn't be surprising to see some more steady buying start to come in.'

Analysts were quick to respond, some with downgrades.

'Hold'

Shore Capital demoted the stock to 'hold' from 'buy', as did Charles Stanley's Sam Hart.

'Clearly the UK business is in much worse shape than we had realised and is going to require significant investment over the coming years, calling into question the group's ability to drive growth overseas. Following today's sharp fall in the share price, the shares look inexpensive, but visibility is poor and we see low single-digit growth in earnings and dividends at best over the medium term,' explains Hart.

He highlights stress points ahead including 'the challenging consumer environment in the UK and early signs of more cautious consumer behaviour in overseas markets means more strain than anticipated has been put on profitability during the important seasonal trading period.'

But not all were so pessimistic. Freddie George at Seymour Pierce retained his 'hold' recommendation and target price of 400p, along with a pre-tax profit forecast of £3.698 billion.

However, he cautioned: 'Whilst we see major opportunities internationally, we need to be convinced that its new UK strategy will return the business to growth and are uncomfortable with the number of recent management departures.'

'Buy'

Over at Panmure Gordon, Philip Dorgan maintained his 'buy' stance but did not mince his words: 'This is the nightmare scenario and our bear case target price of 280p comes into play. However, we believe that Tesco will eventually get it right, although it would be nice to have some evidence to back this up. We remain buyers, but we are reducing our target price from 500p to 440p.'

Dorgan was not alone in his assessment and a 'buy' rating was held by Nomura. 'While we do not interpret this to mean leading like-for-likes, or perpetually increasing share, we believe Tesco will set out its stall to do what is necessary to sustain best-in-class operating metrics and returns, underpinned by like-for-like growth at a market rate or better,' it said.

This was written for our sister website, Interactive Investor

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