Tesco has been on a tear this year. Shares in the FTSE 100 grocer have climbed by roughly a quarter as investors have lapped up sales growth, profit upgrades and buybacks. But are the shares still good value?
Shares in Britain’s biggest grocer have yo-yoed for the best part of the past decade, partly because of the fallout from an accounting scandal in 2014. But the stock has undergone a remarkable rerating in the past two years under the leadership of Ken Murphy.
Murphy, who took the top job during the pandemic in 2020, has pursued a four-pronged strategy: a focus on value, loyalty schemes, customer convenience and efficiency savings. So far this has been successful: Tesco, which has a 27.8 per cent share in the grocery market, has lowered prices on thousands of its products, which in turn has attracted more shoppers and boosted its top line. That method was particularly effective during the cost of living crisis, especially when combined with the popularity of its Clubcard loyalty programme.
This helped operating profit to rise by 13 per cent to £1.61 billion in the first half, up from £1.43 billion in the same period last year and a 7 per cent beat against analyst expectations. Sales were up 3.5 per cent to £31.5 billion and like-for-like sales rose by 2.9 per cent.
Murphy also reported that shoppers were in good shape before the crucial Christmas period and were already starting to treat themselves to more expensive goods in October. It was enough for Tesco to upgrade its profit outlook for the year to about £2.9 billion, having previously guided for at least £2.8 billion.
A bright spot this year has been its premium products. There was a 15 per cent increase in volume of sales in its Tesco Finest range in the first half of its financial year, compared with the same period last year.
Tesco is also preparing to relaunch its F&F clothing line online next year as it moves to pick up on demand for affordable clothing. This may ring alarm bells, however, especially as other supermarkets have struggled in this area. Its rival Sainsbury’s said this year that it planned to replace some of its own-brand clothing space in shops with more food aisles after fashion sales slipped. Meanwhile, like-for-like sales at Asda’s clothing line, George, dropped 3.9 per cent in its second quarter.
Still, overall the picture at Tesco looks healthy, with strong sales, profits and a modest 30-basis-point improvement in adjusted operating profit margin to 4.5 per cent in its retail business. That is not to mention a stronger balance sheet, with net debt falling in the first half by £212 million to £9.68 billion, including leases. That equated to a net debt to adjusted cash profit ratio of 2.1, below its target range of 2.3 to 2.8.
There is still plenty of cash available to flow back to shareholders too, with retail free cash flow (which excludes Tesco Bank) expected to end the year somewhere between £1.4 billion and £1.8 billion. The stock is expected to yield 3.9 per cent over the next 12 months, broadly in line with the wider FTSE 100.
Shares in Tesco have delivered a total return of 35 per cent since mid-April, when this column last rated the stock as a buy. At that time the shares traded at a forward price to earnings multiple of just 12, around its lowest level in a decade. The rally in the share price has moved this up slightly to 13.6, though this still stands noticeably below its 10-year average of 17.3. For a group with huge scale, market leadership and ongoing growth, Tesco looks like it is still in very strong shape.
Advice Buy
Why Shares still inexpensive relative to leading market position and strong growth
Halfords
Halfords was a stock market darling during the pandemic, thanks to a boom in cycling, but the company has fallen off track as it grapples with a slowdown in the market, weaker spending, bad weather and higher costs. Still, the stock is expected to yield 5 per cent over the next 12 months, so could it be worth a punt?
The retailer, which specialises in goods and services for motorists and cyclists, has been hit hard by the cost implications of a rise in national insurance contributions and minimum wage coming into effect from next April. It has 377 retail shops and 550 garages and employs more than 12,000 people.
Halfords has not laid out how exactly these higher costs might trickle down to its customers, but it said in November that it expected a £23 million increase to its direct labour costs, of which only about £9 million had already been baked into its plan for 2025-26.
Its operating performance has been uninspiring: there was a 1 per cent drop in revenue in the first half from £873.5 million to £864.8 million in the six months ended September 27. Pre-tax profits dropped 23.3 per cent to £17.8 million and Graham Stapleton, its chief executive, warned of an “uncertain” trading outlook last month.
There is some excitement around some of Halfords’ projects, including its loyalty motoring club that is now more than four million members strong, and strong growth in its “Fusion” centres, which join up its services in-store and in-garage. City forecasts suggest that Halfords will yield 5 per cent over the next year, ahead of the wider FTSE All Share index at 3.9 per cent.
But the shares have dropped 29 per cent since this column rated Halfords as an “avoid” in November of last year, when the possibility of a firm takeover offer seemed like the best hope for shareholders waiting for a re-rating. Just over a year later and with the shares trading at around the 150p mark, this still remains the case, with still no clear signs of a recovery in either cycling or tyres.
Advice Avoid
Why Weak outlook in core market
