The Tesco (LSE: TSCO) share price has held up well this year as stock markets have been volatile. The stock is up 2.5% so far in 2022. However, over one year, the share price is down by 2.5%.
I think the stock can keep rising from here though. I’ve been impressed by Tesco’s strategy and improving fundamentals. Let’s take a look.
A rising Tesco share price
The pandemic has had a major impact on shopping habits. It’s meant consumers are ordering far more online nowadays, including home delivery of groceries.
Tesco is leading the way in this shopping channel relative to its competitors. In fact, Tesco almost doubled its online delivery capacity during the pandemic. According to a recent trading update for the 19 weeks ended 8 January, the company said it had the highest total market share in four years. This included online shopping where it continues to grow relative to its competitors.
The company has been innovating in this channel, too. Its Tesco Whoosh initiative is targeting superfast home delivery, which is now in more than 100 stores. Tesco is showing it can compete with the likes of smaller start-up companies in this area, such as Getir, even though it’s an almost £23bn company and member of the FTSE 100!
Financial trends and earnings are improving, too. In the recent trading update, both one-year and two-year like-for-like sales were positive across the UK and Central Europe. This meant Tesco upgraded its retail operating profit above the top-end of its previous expectations.
For the full-year to 28 February, City analysts now forecast operating profit growth of 25%. If this growth is achieved, the shares would be valued on a price-to-earnings ratio of 14. This isn’t particularly high, especially if the company keeps growing market share and earnings.
Risks to consider
Food retailing is a highly competitive market, with little in the way of differentiation between the businesses themselves. For instance, Tesco, Asda and Sainsbury’s are largely the same and simply compete on price.
Tesco also failed in its wider international expansion because it had no lasting advantage against other brands. It sold its Polish business, and exited Thailand and Malaysia. These aggressive expansion plans did lead to debt issues for the company, which have now been largely resolved. Nevertheless, it is something to monitor if Tesco embarks on similar plans in the future.
Should I buy Tesco shares
If I was to buy Tesco shares, it would primarily be for its income potential. Indeed, the cash flow generation forecasts for the company are excellent in the years ahead. In fact, analysts are expecting over £1.8bn in free cash flow for the next three years. This would be an annual free cash flow yield of 8% based on Tesco’s market value today.
Because of this cash generation potential, I’m expecting the dividend to rise in the years ahead. Not only this, but Tesco could well start a share buyback scheme. This would boost earnings per share, and hence the share price should also keep rising. So, today, I’d consider adding Tesco shares to my portfolio.
Dan Appleby 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.
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