Tesco's Booker deal triggers 11% rally

This week was looking pretty grim for Tesco. A stunning recovery since the summer looked to be unwinding, despite reasonable third-quarter results, and shares in the supermarket closed last night at their lowest since early October. Then, Bam! A £3.7 billion bid for cash-and-carry giant Booker gets the City interested again; but should you be?

It's marketed as a merger, but make no mistake, this is Tesco buying Booker. Their shareholders will receive 0.861 Tesco shares plus 42.6p in cash, valuing the company at £3.7 billion.

Clearly, the City likes the deal, as investors chased Tesco up as much as 11% to 210p where the shares haven't traded since before the 12 January update.

"A surprising move but one not without merits," muses Gary Hobbs, senior equity analyst at Investec Wealth & Investment. "It takes Tesco much further into wholesale, giving greater certainty of supply and allowing it to extract better terms."

Boss Dave Lewis promises a pre-tax benefit of "at least" £200 million a year by the end of the third year after completion. He forecasts a £25 million boost to revenue, too, although admits this could be conservative, and cost savings of £175 million or more.

Crucially, we're told Tesco will also return to the dividend list in the financial year ending February 2018. They'll target dividend cover of two times over the medium-term.

A rally at Tesco Friday implies a value for shares in the Budgens and Londis owner at about 220p, a 20% premium to yesterday's close and a new high. Six weeks ago they were just 168p.

And Tesco has had to pay up for Booker. Investec tipped the cash-rich wholesaler to make a profit of £171 million in the year to March, rising to £191 million next year. On forecast earnings per share (EPS) of 8p and 8.9p respectively, that gives a forward price/earnings (PE) ratio of roughly 27 and 25 times.

Booker's rank-and-file shareholders will almost certainly back the takeover. Competition authorities will want a closer look, though.

Hobbs says that, on a call with analysts this morning, Lewis was optimistic that the Competition and Markets Authority will cut Tesco some slack. Booker's store chain is franchised, so Tesco will have no influence over pricing.

However, and despite slimming down its empire since Lewis took over in 2014, Tesco's expansion across convenience stores will certainly trigger interest.

Assuming it gets the green light, the acquisition will probably turn out well for Tesco. Yes, the weak pound increases costs and inflation is on the rise, but the existing business remains in recovery mode, with full-year like-for-like sales tipped to beat consensus estimates.

The uptick in profit had likely been priced in, true, but Tesco has begun winning market share again for the first time in five years. There's plenty to distract management here, but I'd rather be buying Booker than Argos.

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.