Is Tesco’s share price overvalued after 12% gains?

Tesco’s share price has delivered some decent gains so far in 2023, even if it lags its two major competitors. However, with profits likely to be flat for the full year and the ongoing cost-of-living crisis, the stock could be overpriced with few growth drivers.

• Tesco’s share price up over 11% in 2023, but lags Sainsbury’s and M&S.
• Price-to-earnings ratio higher than sector average.
• Tesco shakes-up senior management, new chair to start 1 September.

Is Tesco’s [TSCO.L] share price really overvalued? According to data from Simply Wall Street, the stock has a trailing 12-month price-to-earnings (P/E) ratio of 24.6x compared to the peer average (16.2x), suggesting that it is more expensive compared with its rivals. However, on a forward basis, Tesco’s P/E drops to 11.09, which is just under Sainsbury’s [SBRY.L] 12.53x and M&S’s 12.42x.

Tesco’s share price has returned shareholders nearly 12% gain this year. While that’s not to be sniffed at, Sainsbury’s shareholders have bagged a 24% return and M&S [MKS.L] shareholders an even better 67% return. But have Tesco shares got any more upside left in them?

What’s happening with Tesco’s share price?

Tesco’s share price might be up this year, but over the last few months, momentum has flagged. Since hitting an intraday high of 285.3p on 10 May, Tesco’s share price has fallen 10%, while Sainsbury’s share price has fallen over 6% over the same period as interest rate hikes, rising costs and unfavourable macroeconomic conditions have begun to weigh on the sector.

M&S is an outlier here, with its stock up over 23% in the same timeframe, largely due to a turnaround program that has seen the grocer revamp its food and clothing offering and modernise its supply chain.

How did Tesco perform in the first quarter?

Tesco delivered £15.2bn in revenue in the first quarter, excluding fuel, up 8.8% compared to the same period last year. Large store sales growth was particularly strong at 9.9%.

Tesco’s sheer scale has helped to keep costs down and extend promotions like its Aldi Price Match to around 700 more products. Its Clubcard Prices are now available on over 8,000 lines. Cost-cutting initiatives will hit margins, but preventing customers from switching to discounters is important as the cost-of-living crisis affects how much shoppers have to spend and where they spend it.

However, even Tesco isn’t immune to the squeeze, with the supermarket saying volumes were impacted in the first quarter, particularly on non-discretionary items.

Despite the sales growth, retail adjusted operating profits are expected to be flat for 2023/24, with retail free cash flow of between £1.4bn and £1.8bn. Last year, retail profits were down 6.3% year-on-year as Tesco invested in its customer offer, and rising prices from inflation ate at the bottom line.

Among the analysts, Tesco’s share price has a 302p 12-month median price target. Hitting this would see a 20% upside on Friday’s close.

Tesco shakes up management team

Gerry Murphy will join Tesco as chair in September. The Irish businessman and former Kingfisher [KGF.L] CEO will replace former chair John Allen, who stepped down from the position in May following serious allegations of improper conduct. Managing director of Tesco-owned One Stop Sarah Lawler has been promoted to managing director of Tesco Convenience, with a view to improving the grocer’s small store operations. Lawler takes over from Kevin Tindall, who has been made managing director for large stores.

Tesco isn’t has made its share of gaffs. At the end of July, it had to recall one of its own brand cooking salts for fears it contained plastic. Consumer group Which? also said the grocer could be breaking the law over its clubcard pricing. Which? Said that how unit prices of clubcard deals are displayed was not clear and made it hard for shoppers to compare product prices.

Where next for Tesco shares?

A flat profit outlook was never going to do Tesco’s share price any favours, and there remain risks to the stock’s performance, notably a further squeeze on shoppers’ wallets. There are also little in the way of clear growth drivers for Tesco’s share price, aside from an easing in the UK economy — something beyond any supermarket’s control.

Still, it’s also worth remembering that Tesco is a mature business that occupies a top spot among UK grocers. In the 12 weeks to 9 July 2023, its market share was 27%, with its next nearest competitor Sainsbury’s, at a 14.9% share, according to data from Kantor. For Tesco, it is about maintaining this position and fending off any customer exodus to discounters.

Another way to look at Tesco shares is as a potential income play. The stock offers a forward 4.27% dividend yield backed by a decent balance sheet and its dominant industry position.