“Exceptionally strong” sales

With most of us stuck indoors, it’s unsurprising that Tesco reported that it had seen “exceptionally strong” sales in the year to the end of February. 

Group sales (excluding fuel) rose 7.1% to £53.4bn. No less than £48.8bn of this came from the UK (up 8.8%) with the remainder coming from operations in Europe and Tesco Bank. Predictably, online sales rocketed over the trading period — up 77% to £6.3bn.

Unfortunately, all this didn’t translate to the bottomline. On a statutory basis, pre-tax profit tumbled by almost 20% to £825m thanks to massive coronavirus-related costs. The move to repay the Government £585m in business rates relief also had an impact. Although not unexpected, this may help explain today’s reaction.

Tesco’s decision to maintain rather than increase the amount of cash it returns to investors, although prudent in my book, may have also annoyed some. Today’s final dividend of 5.95p per share brings the total payout for the year to 9.15p per share (ignoring the special dividend paid in February). Taking into account the Tesco share price as I type, this gives a yield of 4.1%. That’s still more than I could get from the FTSE 100 as a whole (3.1%).

Still a ‘buy’ for me

Of all the listed supermarkets, Tesco has been my firm favourite for a while. Today’s share price reaction won’t change that.

At 27.1% (and despite the rise of the German discounters), the company still has a commanding share of the UK grocery market. In fact, Tesco commented today that it had actually increased its dominance over the last year and gained customers “from all key competitors“.  Factor in its incredibly popular Clubcard scheme and I don’t see Tesco losing its crown anytime soon. 

Another reason for being bullish on the Tesco share price is the company’s outlook. While sales may moderate this year, the £18bn cap does expect “a strong recovery in profitability” as costs relating to the pandemic won’t repeat in FY22. In fact, Tesco now believes retail operating profit might be similar to that seen in 2019/20 financial year.

Reasons to be wary

Of course, this isn’t to say there’s nothing to be wary of. For one, the online part of the business is still loss-making. I don’t see this situation changing radically for a while. Prospective buyers like me also need to be comfortable with the possibility of a third Covid-19 wave and the knock-on effect this could have for Booker, Tesco’s wholesale, hospitality-focused division.

On top of this, the performance of the Tesco share price has been nowhere near as good as other companies in the index, even if we take into account the 15-for-19 share consolidation in February. The FTSE 100 itself is up 19% in one year. Based on this, it may have been less stressful to buy a diversified FTSE 100 tracker and do nothing. 

Yet I continue to regard Tesco as a good option for FTSE 100-focused, defensive-minded investors like me. A valuation of 11 times forecast earnings looks reasonable, even if a full share price recovery will take time. I regard today’s fall as an opportunity and would be happy to buy. 

The post The Tesco share price is falling. Here’s why I’d buy appeared first on The Twelfth Magpie.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. 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.

That said, for every tiddler that soars, there are hundreds of doomed or overpriced operations that beguile investors with attractive predictions about the future. And even if you avoid the bad businesses, overpaying for quality could still destroy your wealth.

Today I’ll explain why I believe Koovs (LSE: KOOV) and AO World (LSE: AO) could destroy your wealth.

Cancel Koovs

Owning the ‘ASOS of India’ is an attractive prospect, especially when you throw in 151% revenue growth last year.

On the one hand, comparisons to ASOS seem apt, given Koovs’ strategy to sell own-brand clothing alongside popular international brands such as New Look, Lipsy and even pieces from UK success story Boohoo.Com.

Yet unlike ASOS, Koovs is burning through its dwindling cash-reserves at an incredible rate. The company has employed an aggressive strategy, heavily investing in infrastructure and marketing to drive sales. There’s nothing wrong with investing ahead of the curve – in fact it’s often essential for e-tailers, but I believe Koovs is getting carried away.

The company’s operations registered a cash loss of £12m in the first half of last year. The business model looks flawed to me and it isn’t even profitable at the gross margin level, with product costing £4.8m compared to £4m revenue in the last six months.

I believe the company has around £15m-16m cash currently. That barely covers the last six months’ cash-burn.

That’s not to say Koovs wont become the ASOS of India. It very well might. However, such a glamorous status doesn’t guarantee shareholder returns and investors are likely to be diluted heavily through further fundraising.

That risk, combined with the already demanding £81m market cap for an unprofitable business, in my experience, more often than not results in a painful ride for shareholders.

Great business, bad industry 

AO World is on a mission to become the best electrical retailer in Europe. Even if successful, I’m not sure this vision is compatible with creating shareholder value.

There’s a lot to like about AO World if you’re a customer. A wonderful focus on customer service, fast delivery and a vast selection makes the website a compelling place to shop. But I believe investors are paying a rather rich price for what is essentially a distributor.

The company reported 10.3% revenue growth in the third quarter, a solid result for a larger company but a little underwhelming considering the multiples the shares trade on.

The company has a market cap of £664m, roughly on par with sales in the last 12 months, yet the company still failed to generate an operating profit. It has already achieved considerable scale in sales. If it can’t yet make a decent profit, I’m worried it will never fulfil the lofty expectations demanded by its valuation.

That said, AO World has one major advantage over Koovs. It seems to be generating enough cash from operations to drive the majority of its own expansion, thus reducing the dilution risk for investors.

The post These small caps could destroy wealth. Make sure it’s not yours appeared first on The Twelfth Magpie.

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Zach Coffell has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.