If I had £1,000 to invest today, I’d buy Tesco (LSE: TSCO) shares without delay. The reason why I’d focus on this company over all the other stocks listed on the London Stock Exchange is simple. I believe Tesco is the best business in the relatively defensive sector of food retail.
I also think the company has the potential to become an income champion over the next few years.
The outlook for Tesco shares
Tesco has come a long way since its accounting scandal in 2014. Since then, its management has completely overhauled the company, refocused the business, and expanded into wholesale. As part of these initiatives, the group exited Thailand and acquired UK wholesaler Booker.
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The group returned some of the proceeds from its business sale to shareholders and used the rest to repay debt, strengthening its balance sheet. By acquiring Booker, the company also strengthened its position in the UK food retailing market. Booker supplies thousands of smaller retailers around the UK.
And now the business looks set to embark on its next stage of growth, which will focus on consolidating the firm’s position in the UK retail market. I think this could have a considerably positive impact on Tesco shares.
To do this, last year the firm launched its new Clubcard scheme. Copying the model used by US retailer Costco, Clubcard holders can choose to pay a monthly fee and receive money off their shopping under the new system.
There are also benefits for subscribing to Tesco’s mobile business and with Tesco Bank products.
As well as this scheme, management has been expanding the mobile division and paid £123m to buy the 50.1% stake in Tesco Underwriting from former joint venture partner Ageas UK. This will allow Tesco Bank to provide an end-to-end insurance offer for Tesco shoppers. Previously, the group had relied on a selection of other insurers.
One-stop-shop
The way I see it, Tesco is creating a one-stop-shop for its customers to buy everything from groceries to financial services and mobile phones. And by doing so, customers can lower their costs. The package of products will also give Tesco more data, which can be used to increase sales.
I think all of these initiatives will help reinforce the firm’s position in the UK grocery market. According to analysts, they could also help the company generate as much as £1.2bn per annum in free cash flow. I think that implies the stock’s dividend could rise substantially as we advance. At the time of writing, Tesco shares offer a dividend yield of 4.4%.
Of course, Tesco isn’t guaranteed to hit this level of cash generation. Significant risks and challenges include rising costs, which could hurt the company’s profit margins. Another wave of coronavirus may also damage the UK’s economic recovery, hitting demand for certain goods and services.
Still, despite these risks, I’d invest £1,000 in Tesco shares today based on the reasons I’ve outlined. As the company enters its next stage of growth, I think the outlook for the stock is improving.
