Tesco slips on concerns market may be overestimating recovery

Discussion in 'Market News' started by Lily, Mar 23, 2016.

  1. Lily

    Lily Forum Member

    Aug 29, 2015
    Likes Received:
    Broker Stifel issues sell note and warns of competition from Amazon

    Supermarkets are turning in a mixed performance, with Sainsbury’s edging higher as analysts weigh up the benefits of its proposed purchase of Argos-owner Home Retail Group.

    Sainsbury’s is up 2.6p at 282.6p, but Tesco is heading in the other direction, down 2.8p to 198.85p as analysts at Stifel cut their recommendation from hold to sell with a 167p price target.

    We think Tesco is executing far better in UK stores, with a significantly improved value proposition, and that this is likely to sustain the recent improvement in trading. However, we think the market has become too optimistic about how quickly this might translate into meaningful profit improvement.

    Tesco trades on a near 6% 2018 estimated free cash flow yield on estimates incorporating a healthy UK margin recovery, while Morrisons and Sainsbury’s both trade on around 7% on expectations that assume margins move sideways. Valuing Tesco on a 7% free cash flow yield, consistent with our valuation for the rest of the sector, determines our target price of 167p, downside of 17%.

    The main drivers to date of improved like for like growth for the Big 3 quoted grocers have been reduced net new space growth and Asda’s market share losses, neither of which are likely to be continued sources of growth. Also, far from being optimistic about the potential return of inflation to UK grocery, we think there is a very real risk of it driving renewed gross margin pressure as retailers seek to gain volume by not passing through higher input costs. Even if some inflation does creep through, we think volume growth will likely fall to offset this benefit. Tesco also has the most to lose if, as we expect, Amazon puts online grocery profitability under pressure.

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