Tesco PLC (LON:TSCO) has made significant headway against an inherently sceptical market, UBS said as it repeated a ‘buy’ recommendation on the stock and raised its target price to 315p from 305p.
In a note to clients, UBS's analysts said consistent margin rebuild in the UK business and like-for-like sales growth outperformance reflects “genuine reconnection” with shoppers and “superior terms of trade” resulting from “innovative approaches“ with suppliers.
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They noted that Tesco's return on equity rose to 8.8% in fiscal year 2019, up from 5.6% in 2016, with asset turnover now the highest since 2010.
“The fitness of the business has much improved, paving the way for the multiple mid-term growth opportunities in the offing,” the UBS analysts added.
However, the Swiss bank's analysts noted that the market remains “inherently sceptical” with the share price little changed year-on-year and consensus estimates for 2021 earnings per share of 19.8p still 7% below management expectations.
Capital markets day preview
Tesco is due to present its current strategy at an upcoming capital markets day on June 18. The UBS analysts said they see opportunities, particularly in the UK and Asia.
In the UK, they believe the combination of Tesco and its wholesale business Booker has an “extensive competitive moat” in the higher-margin foodservice channel.
“The majority of the remaining £2.0bn merger incremental revenue target should drop through at higher margins of 4-5%,” they added.
In Asia, the UBS analysts think Tesco’s capabilities in developing own brand products and its meaningful scale in the Thai market present upside to mid-term margins.
First quarter estimates
However, the overall UK market has slowed in May compared to a year ago when an unusually warm summer, the royal wedding of Prince Harry and Meghan Markle on the same day as the FA Cup final all boosted sales.
Tesco publishes its first quarter trading update this Thursday. For the first quarter, the UBS analysts expect Tesco to report a 0.7% increase in UK like-for-like sales, with 4.5% growth for wholesealer Booker. But they see like-for-like sales in central Europe falling 1.5% and like-for-like sales in Asia dropping by 0.5%.