Tesco shares: a potential source for second income

Over the past year, investors like myself have been wary of potential dividend cuts due to the cost of living crisis. Tesco (LSE:TSCO) is one example. But with the sound plane of Q3 numbers, the stock still has the potential to become a second source of income for me. Here is the reason.

A good Christmas update

The company’s latest Q3 update may be an indicator that the declining profits may be due to a number of reasons.

The first is that sales seem to be seeing an acceleration of growth, compared to last year. And while the Q3 growth rate was admittedly lower than Sainsbury’s and Marks and SpencerIt is worth noting that Tesco’s profit is larger, which makes the growth percentage appear smaller.

As-is sales (e.g. fuel)	Christmas	Q3 2023	Q3 2022
Tesco	7.9%	5.7%	2.4%
Sainsbury’s	7.1%	5.9%	-4.5%
Marks and Spencer	N/A	7.2%	18.5%

The second is to repeat our original guidance for FY23. The board still expects adjusted operating profit of between £2.4bn and £2.5bn, free cash flow of at least £1.8bn, and adjusted operating profit of around £120m to £160m for the banking business.

Although the majority of these figures are still forecast to be lower than FY22, there is still a sense that margins will not fall. This clears the way for margin expansion in the medium term. This will allow the group to continue paying dividends, and even potentially increase payouts in the future.

Eat away the competition

Another positive is Tesco’s market share gains. The UK’s largest supermarket continues to strengthen its position as market leader as it is reported to be the only full-service grocer in the country to grow its market share from 2019. But what is even more impressive is its ability to hold onto market share. last year, despite the rise of Aldi and Lidl.

What’s more, the FTSE 100 His catering business, Booker, continues to grow its market too. The arm’s third-quarter sales rose 5.7%, with Christmas sales up 7.9%. In addition, banking division sales increased by 14.6%.

Although this division only contributes a minuscule amount to Tesco’s underlying figures, a larger margin can positively impact dividend payouts in the future.

All that said, would I consider Tesco shares a buy for my portfolio? Well, progressive dividends are always profitable and double covered. Additionally, the company’s balance sheet, while not the best, isn’t terrible with a healthy debt-to-equity ratio and healthy free cash flow.

Furthermore, food inflation also started to decrease. And with the impact of lower commodity prices yet to materialize, this should allow for margin expansion in the second half of the year.

However, I question whether the combined gains from the stock price and future dividends outweigh the potential returns of other stocks. Some multiples of the stock’s value are trading at a discount which may represent a bargain.

Metric	Multiples of value
Price-to-earnings (P/E) ratio.	19.8
Price-to-sales ratio (P/S).	0.3
Price-to-book (P/B) ratio.	1.4
Price-to-earnings growth (PEG) ratio	0.2

However, I am of the view that there are other stocks with stronger growth potential, higher dividends, and more profits. Thus, I am more inclined to agree with Shore Capital’s ‘hold’ rating on Tesco shares, as I would not buy them if given a better option for further income.