Yahoo Finance Questor: This supermarket is a bargain buy for investors right now
Investors are far too pessimistic about the UK stock market’s long-term prospects. Certainly, inflation remains above target, interest rates stand at a 16-year high and the economy is experiencing a recession.
But the rate of price rises is widely expected to return to the Bank of England’s 2pc target over the coming months, thereby allowing interest rates to be cut and the economy to return to positive growth.
This process is extremely likely to have a positive impact on UK share prices. In the meantime, investors have an excellent opportunity to buy high-quality companies while they trade at attractive prices due to ongoing short-termism among the investment herd.
Indeed, Questor will use this buying opportunity to increase the number of UK-listed stocks in its income portfolio. Excluding investment trusts, the portfolio currently only contains one UK-listed company, Legal & General.
But over the near term, this list will be expanded to include a wide range of solid businesses that provide sound income-investing prospects over the long term.
The first addition in this process is Tesco. It was first tipped as a buy in this column in October 2017, but has not yet been a holding in our income portfolio. Its share price has risen by a rather disappointing 22pc since our original tip, although it has outperformed the FTSE 100 index by 15 percentage points.
According to its recently-released full-year results, the retailer is making encouraging progress.
The company’s sales rose 7.2pc, while earnings increased 14pc on a per share basis. This allowed the firm to raise dividends per share by 11pc, which is more than three times the current rate of inflation.
When combined with a lacklustre share price performance over recent months, this means that the firm currently yields 4.2pc. This is 50 basis points higher than the FTSE 100 index’s dividend yield.
Crucially, Tesco’s dividend was covered 1.9 times by profits in its latest financial year. This shows it has sufficient headroom when making dividend payments, which could prove useful as ongoing economic uncertainty continues.
It also means that a large proportion of future profit growth could be passed onto investors via higher shareholder payouts, thereby providing scope for further real-terms dividend growth over the coming years.
The company’s annual results also highlighted its improving competitive position. Its market share in the UK increased in both value and volume terms, with customer satisfaction metrics continuing to strengthen.
Consumers in the UK are likely to become less price conscious as inflation falls, interest rates are cut and the economy’s performance improves.
This should not only support sales growth across the retail sector, but provide opportunities for margin expansion that have a positive impact on profits and dividends.
In the meantime, the firm’s net interest cover in excess of five shows it has ample headroom when servicing debt. The planned sale of its banking operations to Barclays further strengthens its balance sheet and allows for greater focus on its core operations.
It also provides additional capital that is set to be used to fund further share buybacks over the coming months.
Having fallen by 1pc since the start of the year, Tesco’s share price currently offers good value for money on a long-term view. It trades on a price-to-earnings ratio of just 12.4, which suggests that it offers a wide margin of safety and scope for significant capital growth to complement its generous income return as operating conditions improve.
To make room for the new addition to our income portfolio, the holding in VPC Specialty Lending, which is in the process of being wound down, will now be removed. It has produced a 38pc capital loss since being added to the portfolio in January last year, although it has paid or announced dividends amounting to 18pc of our notional purchase price.
In Questor’s view, Tesco offers a relatively attractive long-term outlook from an income investing perspective. The company’s sound market position and solid balance sheet mean it is well placed to benefit from an improving operating outlook that is likely to positively catalyse earnings growth.
This should allow it to raise dividends, which are well covered and already grew at a double-digit pace in its most recent financial year.
With ongoing investor pessimism contributing to a low valuation and a relatively generous dividend yield, the stock has rarely offered greater investment appeal.
Questor says: buy
Ticker: TSCO
Share price at close: 289.8p
Read the latest Questor column on telegraph.co.uk every Sunday, Monday, Tuesday, Wednesday and Thursday from 8pm
Read Questor’s rules of investment before you follow our tips
