Top pick Tesco upgraded again

The momentum behind Tesco (TSCO) and its improving share price continued today as another broker seized the opportunity to upgrade forecasts.

Barclays lifted its price target by 6% to 280p and said the supermarket giant remained its top pick in the European food retail sector.

Today’s note adds to the flow of positive news in support of a resurgent Tesco led by chief executive Dave Lewis. In recent days, Bernstein and Citigroup have upgraded their price targets to 290p, while respected retail analyst Clive Black at Shore Capital has reiterated his ‘buy’ recommendation.

• Why Tesco has a fantastic few years ahead of it

Their confidence is echoed by this week’s Kantar Worldpanel figures showing a sales increase for Tesco of 2.2% in the past 12 weeks, having attracted an extra 170,000 customers to its stores. The retailer’s market share, however, was 0.1 percentage points lower than a year earlier at 27.7%.

Source: interactive investor          Past performance is not a guide to future performance

Having now completed its £4 billion takeover of cash-and-carry chain Booker, Tesco looks well placed to make further advances, particularly if rivals Sainsbury (SBRY)’s and Asda become distracted by their potential merger.

The next landmark for investors will be the company’s first quarter trading update on June 15, when UK like-for-like sales are forecast by Barclays to slow to 1.7% from 2.3% in the previous quarter.

European food retail analyst James Anstead said: “This ought to be considered a very reasonable outcome in the context of slowing inflation and generally unhelpful weather in Q1.”

Other highlights from the update are likely to include projected like-for-like sales growth of 8.5% for Booker in the first quarter since the merger completed.

As well as looking at the trading outlook, today’s note from Barclays draws some interesting conclusions from changes to management long-term incentive plans (LTIP).

The big difference, as disclosed in the Tesco annual report, is that the old benchmark of Total Shareholder Return is being replaced with earnings per share (EPS).

Barclays point out that if management are to be paid out fully for the EPS component then the company will have to deliver EPS of 24.4p for 2020/21, which is 23% ahead of the bank’s current forecasts.

To get just a 50% payout the EPS will have to be 7% ahead of its forecast.

Anstead added: “Tesco remains our top pick in the sector and we are encouraged by the potential EPS upside suggested in the new LTIP.”

His new forecasts take into account the impending closure of Tesco Direct, which generated about £400 million of loss-making sales, as well as recent FX movements.

The net effect is EPS accretion of between 0.5% and 1.5% for the next three years. This earnings growth is likely to be supported by synergies from the Booker merger and the achievement of Tesco’s margin target of 3.5% to 4% for the 2019/20 financial year.

Barclays sees the Tesco dividend yield rising to 2.2% in the current financial year, then 3.2% and 4% in the following years. Tesco recently paid its first dividend in three years, with a 3p full-year pay-out announced in April’s results.

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