2022 has been a bit of a lacklustre year so far for Tesco (LSE:TSCO) shares. It’s not as bad as some of the tech stocks out there. But investors have watched the supermarket stock price tumble by the better half of 10% since the year began.
Over the last 12 months, Tesco shares are still up by around 20%. So while the current downward trajectory is annoying, it’s not exactly a catastrophe. In fact, the price drop could actually be a great opportunity to do some shopping for my income portfolio. Let’s investigate.
The bullish argument
In case it’s somehow gone unnoticed, we’re in a pretty intense inflationary environment right now. The consumer price index is up by 6.2% as of February. And it’s not entirely clear when this will be reversing, even with the Bank of England raising interest rates.
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What does this have to do with Tesco shares? During high inflation, consumer spending tends to drop off a cliff as households seek to save their money. And this effect is only being amplified by the skyrocketing energy bills the UK is currently facing. Fortunately, there are a few things we simply can’t live without – food and water.
Historically, consumer staple businesses are one of the best performers during economic uncertainty. That places Tesco shares in a favourable spot, with cash flows likely to continue unimpeded. And given these are one of the primary deciders on whether dividends are paid, it makes the company’s income prospects as an investment look rather promising.
This is all my opinion, of course. But the latest results do provide some supporting evidence. Total revenue continues to climb steadily in its usual fashion of low single digits. But more impressively is what’s going on with operating profits.
On a constant currency exchange rate, these are up by a massive 58.9% reaching £2.83bn! Admittedly, this is mainly driven by the elimination of Covid-19 impact costs. And therefore I doubt this level of growth will continue. However, operating income is actually higher than pre-pandemic levels by around £300m. And in my experience, when profits are flowing, dividends aren’t far behind.
Tesco shares have their risks
As encouraging as these results are, some potential warning signs are ahead. Demand for consumer staples might not be going anywhere, but Tesco is not the only supermarket in town. With premium product manufacturers like Unilever increasing prices to offset cost inflation, Tesco has to absorb some of this, eating into margins.
Why? Because with consumers going into an ultra money-saving mode, suddenly discount retailers look even more alluring. To remain competitive, management is extending its price-saving initiatives like Aldi Price Match. With margins being squeezed, the company has issued profit guidance for the next 12 months of ‘only’ £2.4bn-£2.6bn.
That’s not heading in the right direction. And is undoubtedly why Tesco shares have stumbled these past few weeks.
Time to buy?
A looming profit cut isn’t exactly a welcoming sight. But in the long term, it may not matter. This business remains the largest supermarket network in the UK and controls 27.7% of the market share. Pair that with a reasonable price-to-earnings ratio of 14, and I think Tesco shares look like a promising addition to my income portfolio.
