What to expect from Tesco at next week’s update

A “cool, calm and collected” Tesco (LSE:TSCO) has been backed to post strong Christmas sales figures as a City bank today highlighted the potential for shares to go 17% higher.

A note by Jefferies previewing next week’s trading update adds that Tesco’s “ample and consistent” levels of cash generation should resonate strongly with investors.

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The bank expects UK retail like-for-like sales growth of 4.9% over Christmas, rising to 7% across the third quarter. That’s ahead of the consensus view of 3.5% and 6% respectively.

Earlier this week, Kantar Worldpanel reported the supermarket sector’s best December since 2019 as Tesco gained 0.1 percentage points of share to now hold 27.6% of the market.

With Jefferies not ruling out upgrades to Tesco’s cash generation and earnings guidance in the 11 January update, it said the market leader entered 2024 in a “sure-footed manner”.

Shares have risen by about 25% to above 300p in the past year but the base case of Jefferies analysts is a decade high valuation of 350p. The upside scenario is 420p, the downside 280p.

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The bank regards the shares as still undervalued on less than 12 times 2024 earnings and a free cash flow yield of about 9%. It highlights the potential for 5% buybacks annually from next year and “appreciable” dividend distributions on a yield above 4%.

It added: “We remain of the view that the broader competitive context should support solid earnings progress at Tesco, and ample and consistent levels of free cash generation.”

Tesco told investors at October’s interim results that it expects free cash flow of between £1.8 billion and £2 billion this year, ahead of medium-term guidance of £1.4 billion-£1.8 billion.

Jefferies said it has written extensively about the improving relative strength of Tesco’s customer offering, which should support strong levels of cash generation.

It continued: “The recent change in rates expectations has driven investors' interest towards more cyclically geared UK peers. This may start changing if progress on inflationary challenges becomes more gradual, and the employment outlook continues to normalise.

“In this context Tesco’s absolute attractions should resonate even more strongly with investors at a time when the group's absolute and relative valuation remain supportive.”

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Jefferies continues to model for retail earnings of £2.76 billion in the financial year to the end of next month, above current guidance of between £2.6 billion and £2.7 billion and the City consensus of £2.72 billion.