Shopping for UK stock bargains

Negative sentiment is weighing on the UK stock market, and that means we can find attractively valued, well-managed businesses trading at a large discount to counterparts in other markets. These businesses include the grocery retailer Tesco, which is benefitting from cost and efficiency programs and is implementing strategies to tackle both the shift to online shopping and the competitive threat from discount chains.

The leader in online grocery sales, and the largest supermarket operator in the UK, Tesco is grappling successfully with two key structural shifts in the UK grocery market: discount supermarket competition and online grocery.

Highly cost-efficient discount chains such as Aldi and Lidl, which offer a no-frills format based on a limited range of products, have been winning market share by focusing on selling goods at low prices. Tesco has fought back by price-matching the discounters and has been more successful than other traditional grocery retailers at protecting its market position.

To protect profitability as it cuts prices to battle the discounters, Tesco has responded with a disciplined approach to containing costs. Strong relationships with suppliers have helped this process. The company has leveraged its scale to obtain the best prices for customers, and during the period of high and rising inflation, it balanced market share with profitability, taking its time to pass on higher food prices.

Other factors supporting profits include:

  • An increase in the share of own-brand (or Tesco-branded) lines, which enjoy greater profitability than branded goods
  • The successful expansion of the company’s high-end own-brand range, Tesco Finest
  • Increasing membership of Tesco’s customer loyalty program, which enables targeted promotions and helps to drive overall spend
  • The unleashing of cost and efficiency programs that have resulted in a much leaner business in recent years.

Secondly, the advance of online grocery sales is threatening the role of physical stores. The company launched in 2000 to exploit this trend, and it now has almost 40% of the online market – higher than its 27% share of the in-store market. It will continue to benefit as shopping shifts further online.

The UK’s densely populated nature, which is key to running a profitable online business, has facilitated the move online. Tesco now has almost nationwide coverage. Learning from Walmart’s experience, Tesco is exploiting its existing supermarket infrastructure by investing in fulfillment centres attached to its large stores and using existing outlets to fulfill online orders. Consequently, the shift to online has not had a significant impact on the business.

Our view is that the stock is attractively valued, particularly given the underlying quality of the business. Tesco is priced at only 11x forward earnings. By comparison, Woolworths in Australia and Walmart in the US are both priced at closer to 25x forward earnings. We see earnings growing by around 3% to 4% per annum, while the company offers a dividend yield of 4.5% and is buying back stock. Given the uncertain macroeconomic environment, the defensive nature of the business – people always need to buy groceries – is also appealing.

You can learn more about the stock opportunities currently available in the UK by listening to this episode of the Good Value podcast.

You can also learn more about why we think the prospects for the UK economy are better than is widely believed here.


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13 December 2023
By Alison Savas By Alison Savas 3 min 3 min