Big upgrade for Tesco

Could the rout at Tesco be over once and for all? Analysts at Deutsche Bank certainly think so. The Big Four supermarkets have turned the corner, it says, and Tesco's expectations are the most realistic. It's why the broker now rates the shares a buy.

Deutsche has slashed forecasts estimates for UK operating profit at Tesco three times since new chief executive Dave Lewis took the job on 1 September. It currently pencils in just £346 million versus £1.6 billion before.

But UK margin is currently tipped to be about 1% in the year to February 2016 - it averaged 5.6% from 2007 to 2013 - which should be a low point, reckons Deutsche. And, after falling by over 60% in the past 12 months, the broker now thinks consensus earnings have troughed.

"Tesco's consensus 15/16 EBIT and EPS has fallen more than peers, despite the fact that only 2/3s of earnings are derived from UK retail (another 6% from bank and the rest from international). We think this gives management the flexibility they need to invest in the offer and improve the sales performance."

Look for adjusted EPS of 9.99p in the year to 28 February 2015, says Deutsche, down from 32p the year before.

Clearly, tentative signs of a rebound in the UK grocery market are encouraging. Kantar food retail sales growth is on an improving trend and like-for-like growth is enough to cover rising costs, easing price competition among the Big Four.

The larger supermarkets are losing less ground to discounters like Aldi and Lidl, too. Deutsche even believes that selling the Thai business could pave the way for a resumption of Tesco's dividend in the year to February 2018, two years earlier than currently anticipated.

Deutsche has done its sums and thinks the Tesco shares are now worth considerably more than previously thought:

We increase our price target from 220p to 275p, largely reflecting a more detailed approach to our SOTP (sum of the parts) valuation. We "gain" c.20p per share from applying a higher multiple to rental income, and c.35p from applying a 7x multiple to a normalised UK retail EBITDA compared to European avg. of c.6x. Downside risks include a slowing of UK sales growth, and lower than expected cost cutting leading to lower earnings.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.