It’s been an incredible start to 2015 for investors in Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US). That’s because, after an awful 2014 when the company’s share price collapsed by 44%, it has risen by a staggering 18% in just eleven trading days.
Clearly, such a rate of growth will not continue, but there does appear to have been a recent shift in investor perceptions of Tesco. While it was seen as something of a ‘basket case’, it is now viewed as a turnaround story, with a large number of investors seemingly willing to back its new management team.
And, looking ahead, it could continue its recent rise all the way to 275p. Here’s how.
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A New Strategy
As was inevitable with a new management team, Tesco is adopting a new strategy. This includes a mix of cost savings and other attempts to revitalise the company’s top and bottom lines. For example, Tesco has put in place a wage freeze, is making redundancies at its head office, and is set to close a significant number of unprofitable stores.
In addition, it’s simplifying its ranges, which means reducing the variety of products it sells in favour of stocking more of its best-sellers. This should make more efficient use of its space, leading to reduced costs and more competitive prices for consumers.
Furthermore, Tesco is also set to make a number of disposals, including the on-line film player, Blinkbox, and its data company, Dunnhumby. This should help to rationalise its operations and make the company more focused on its key business: food retailing. And, although it will take time for its renewed focus on customer service and the refurbishment of stores to have an impact, as well as any possible re-branding, Tesco looks set to appeal more to price-conscious customers in future than it has done in the past.
Looking Ahead
While Tesco is expected to see its bottom line fall by a whopping 65% in the current year, its forecasts for the next two years are much more positive. For example, net profit is expected to increase by 1% next year, followed by growth of 22% in financial year 2017. As such, it appears as though the market is now looking ahead to the company’s turnaround potential and also to much more prosperous times in the next two years.
In fact, focusing on forecasts for the next two years means that Tesco trades on a highly enticing valuation. For example, it has a two-year price to earnings growth (PEG) ratio of just 0.7, which provides evidence that the company offers growth at a reasonable price. And, even if Tesco were to trade at a higher PEG ratio of 0.9 (which remains hugely appealing and thus very realistic), it would mean its shares being priced at around 275p. In other words, over the medium term, gains of 23% (to 275p) seem very achievable and would still leave Tesco on a very appealing valuation.
As a result, recent share price growth could prove to be the start of Tesco’s comeback, with investor sentiment on the up and having the potential to push its share price significantly higher. Therefore, now could be a good time to buy shares in Tesco.
