After Tesco shares spike sharply upwards, are they still a buy?

At the end of September, I wondered whether the Tesco (LSE: TSCO) share price might come under pressure in October. We’re only about a week in. But the answer, at least so far, appears to be no. Tesco shares are already up 8.5% in the month, boosted by first-half results released 6 October.

Tesco does not appear to be afflicted by the current supply chain problems. The company said: “As industry supply chains came under increasing pressure, we were able to leverage our strong supplier relationships and distribution capability to maintain good levels of availability for customers“.

In the first half, Tesco saw a 2.6% rise in sales. With lower Covid-19 related costs than in the same period a year ago, that led to a fat increase in profits. On a statutory basis, operating profit rose by 29.5%. But on an adjusted basis, Tesco recorded an operating profit gain of 40.6%. A chunk of that, though, came from Tesco Bank swinging from a £155m loss last year to a £72m profit.

Bottom line adjusted EPS jumped 54%, and the interim dividend was left unchanged at 3.2p per share.

Liquidity is key for me these days. And it was cheering to see Tesco reporting a near doubling in retail free cash flow, to £1,543m. The debt situation is improving too, with net debt reduced by 18.5% to £10.2bn.

Improved outlook

I’m wary of reading too much into this one set of results. Might we be seeing a one-off post-pandemic surge? Might it ease off, and might Tesco shares fall back again? Against that thought, though, I am buoyed by Tesco’s upgraded outlook.

The board says that “we have increased our adjusted retail operating profit expectations for this financial year to between £2.5bn and £2.6bn.” And it now expects “Tesco Bank to deliver adjusted operating profit of at least £120m for this financial year“.

Tesco also had good news on the dividend front. The update said that “we will aim to grow the dividend per share each year, broadly targeting a pay-out of around 50% of earnings“.

And Tesco has become another in a growing number of FTSE 100 companies embarking on share buyback programmes. Tesco announced a first tranche of £500m in shares to be repurchased by no later than October 2022. We’ll hear more on how that is going at full-year results time in April 2022.

Are Tesco shares good value?

Right now, I see Tesco shares as decent value. Not screaming cheap, but not overvalued, and with decent long-term potential. There’s certainly some downside, which I see as mainly coming from the renewed growth ambitions at Lidl and Aldi. Each is on its own £1.3bn expansion plan. I can see pressure on the Tesco share price from that, and I still think the rest of the year could be weak.

But Tesco does have competitive advantages, and I’ll just mention one here that I think is key. CEO Ken Murphy said that “the resilience of our supply chain and the depth of our supplier partnerships has once again been shown to be a key asset“. I think he’s right. Tesco is a buy candidate for me.

Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.