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Over the past year, investors like me have been wary of potential dividend cuts as a result of the cost-of-living crisis. Tesco (LSE:TSCO) shares have been a case in point. But with a solid set of third-quarter numbers, the stock still has the potential to be a source of second income for me. This is why.
A nice Christmas update
The company’s latest third-quarter update could be an indicator that its declining earnings may finally be bottoming out for a couple of reasons.
The first is that comparable sales saw an acceleration in growth, compared to last year. And while its third-quarter growth rate is certainly lower than Sainsbury’s Y marks and spencerIt should be noted that Tesco’s revenues are much higher, making the growth rates appear lower.
| Comparable sales (for example, fuel) | Christmas | Q3 2023 | Q3 2022 |
|---|---|---|---|
| Tesco | 7.9% | 5.7% | 2.4% |
| Sainsbury’s | 7.1% | 5.9% | -4.5% |
| marks and spencer | N/A | 7.2% | 18.5% |
The second is a reiteration of its original guidance for FY23. The board still expects to achieve adjusted operating profit of £2.4-2.5bn, free cash flow of at least £1.8bn and a profit adjusted operating costs of approximately £120 million to £160 million for its banking business.
While most of these numbers are still forecast to be below FY22, there is some respite in knowing that margins aren’t going to drop any further. This clears the way for margin expansion in the medium term. This would allow the group to continue paying its dividends and even potentially increase payments in the future.
devouring the competition
Another positive was the increase in Tesco’s market share. The UK’s largest supermarket continues to consolidate its position as the market leader, as it reported being the only full-line supermarket in the country to increase its market share since 2019. But what’s even more impressive was its ability to maintain its market share. last year, despite the rise of Aldi and Lidl.
What’s more, the FTSE 100 The firm’s catering business, Booker, also continues to grow in its market. The arm’s third-quarter sales posted an increase of 5.7%, with holiday sales up 7.9%. Additionally, the sales of its banking division increased by 14.6%.
Although these divisions only add a minuscule amount to Tesco’s underlying numbers, their higher margins could have a positive impact on future dividend payouts.
With all this being said, would I consider Tesco shares a buy for my portfolio? Well, the progressive dividend is certainly lucrative and is hedged twice. Also, the company’s balance sheet, while not the best, isn’t atrocious either with a healthy debt-to-equity ratio and healthy free cash flow.
In addition, food inflation is also starting to slow down. And with the impact of lower commodity prices yet to materialise, this should allow for some margin expansion in the second half of the year.
However, I wonder if the combined future gains from its stock price and dividends outweigh the potential returns from other stocks. Some of the stock valuation multiples are trading at a discount, which could indicate a bargain.
| Metrics | valuation multiples |
|---|---|
| Price-Earnings Ratio (P/E) | 19.8 |
| Price-Sales Ratio (P/S) | 0.3 |
| Price-to-book (P/B) ratio | 1.4 |
| Price to earnings growth (PEG) ratio | 0.2 |
However, I am of the opinion that there are other stocks with greater growth potential, higher dividends and wider margins. Therefore, I am more inclined to agree with Shore Capital’s ‘hold’ rating on Tesco shares, as I would not buy them given the array of better options for a second income.
