The UK’s number-one supermarket has reigned supreme for nearly three decades. But can its shares provide me with a rising passive income stream?
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Tesco (LSE: TSCO) became Britain’s most popular supermarket in the mid-1990s and has remained so ever since. But does this dominance make its stock a good candidate to pay me reliable and growing passive income? Let’s take a look.
One of the things I’ve always admired about Tesco is its adaptability. It has maintained its leading position by constantly adjusting to consumer trends, whether through home delivery or its recent ‘Aldi Price Match’ campaign.
Sir Terry Leahy, the supermarket’s chief executive from 1997 to 2011, thinks the introduction of the Tesco Clubcard in 1995 was a defining moment in the long-term success of the company.
While it didn’t pioneer loyalty schemes, Tesco did harness technological advances to collect raw data on what individual shoppers were buying. It was then in a position to offer personalised rewards and discounts to keep customers coming back.
Today, more than 20m people in the UK have a Tesco Clubcard. I believe this scheme gives it a competitive edge, allowing it to fend off the German discount brands nipping at its heels.
The Tesco share price is up just 1.8% over the last five years.
Now, I think there are two ways to look at this performance. Glass half empty, I could say the share price has gone nowhere and it’s been an investment to avoid.
However, seen from another perspective, I could argue this stability would’ve preserved my invested capital, allowing me to make a return from the dividends.
Personally, if a company’s progressive dividend policy is bearing fruit, I’m inclined to go with the latter interpretation. And since it reinstated its dividend in 2017 following an accounting scandal, Tesco has had a good track record of paying out.
But that’s all in the past. So, what about the future?
Well, looking forward, Tesco is guiding for FY22/23 retail adjusted operating profit between £2.4bn and £2.5bn. And it expects retail free cash flow of at least £1.8bn.
I think these figures are impressive, considering how soaring inflation has been causing problems with its operations. It suggests the company remains in good shape to continue rewarding investors.
At 264p per share, the dividend yield stands at 4.4%. That’s comfortably above the 3.7% average yield currently offered by the FTSE 100. And it’s reassuringly covered nearly two times by earnings.
Better still, if analyst forecasts are met, the supermarket’s yield would rise to just over 5% next year.
Tesco does face other competitors beyond the discounters. Amazon continues to move deeper into the grocery space. Plus, smaller firms such as HelloFresh, the meal-kit deliverer, offer a unique proposition that could draw people away from the company’s superstores.
I don’t expect Tesco to relinquish its market-leading position any time soon. But I do fear that this relentless, cut-throat competition will put pressure on its profit margins. And I think this could ultimately limit its ability to substantially increase its dividend in the years ahead.
As such, I think there are better income stocks out there for my portfolio. I’ll be looking at buying them instead.
Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Ben McPoland has no position in any of the shares mentioned. The Motley Fool UK has recommended Amazon.com and Tesco Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.
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