After a tough few years, is now the time to buy Tesco shares?

As I look ahead to 2023, I am eager to find new companies to add to my portfolio. I often look at more obscure stocks, hoping to identify opportunities other investors have missed. However, this focus on unknown companies may need to be revised. A number is the most popular FTSE 100 staples have dropped significantly in the past year. This means that some high profile companies may enter my valuation territory and may be ripe for my new portfolio.

This is especially the case with Tesco (LSE: TSCO). As one of the largest supermarkets in the world, so it is almost not a hidden opportunity. But the share price has fallen sharply in 2022, down almost 23%. Furthermore, it is down only 28% from the pre-pandemic level, indicating that the market has started to ignore the segment. I am very interested in exploring this company in more detail. Analyzing the companies that sell the goods or services I buy allows me to understand their business model faster than companies whose products I don’t know.

Positive highlights

On the surface, there are elements about sharing that are appealing. It currently has a price-to-earnings ratio (P/E) of only 10.2, far below the three-year average of almost 17. In addition, this level is predicted to remain stable, rising to 10.6 next year. This is below the FTSE 100 median of more than 15.

There are also some core positives in the company’s fundamentals. The current dividend is almost 5% and can be comfortably paid using earnings per share (EPS). This is illustrated by a dividend cover ratio of 2. The elevated dividend appears to be quite stable, as it is forecast to decrease only slightly to 4.8% in 2023. In addition, the dividend cover remains the same.

Another impressive positive metric is generating free cash flow. The company returns the equivalent of 120% EPS per share in cash, which is higher than its three-year average. Furthermore, the efficiency that generates income from the invested capital is also reasonable, with a ratio of return on capital employed (ROCE) of almost 8%. This metric is also higher than the three-year average.

The core challenge

However, the negative share price performance for Tesco is underpinned by the company’s challenging outlook. This stems from the fact that Tesco has a very high level of debt at almost 94% of its market capitalization. Combined with thin profit margins, this can put pressure on the company in difficult times. This explains why the stock suffered during the pandemic year and why the current macroeconomic threat in the UK may cause further damage.

Balance sheets, already weakened by the pandemic, are vulnerable to the combined risks of high inflation and reduced consumer demand following the cost-of-living crisis. This may be why investors are not keen on buying Tesco shares at this stage. If these factors continue, the damage will only increase. The dividend is the first area to take action, and if EPS experiences the expected 4.5% decline, more will be needed.

Therefore, even if the share price is reduced, I do not want to add Tesco to my portfolio at this stage. However, this view may change if broader economic threats begin to subside and core fundamentals strengthen during the year.