The Stock Picker's Guide to Tesco

LONDON -- Successful investors use a disciplined approach to picking stocks, and checklists can be a great way to make sure you've covered all the bases.

In this series, I'm subjecting companies to scrutiny under five headings: prospects, performance, management, safety, and valuation. How does Tesco  (LSE: TSCO  ) (NASDAQOTH: TSCDY  ) measure up?

1. Prospects
Tesco is the world's third-largest retailer, but the U.K. contributes two-thirds of revenues. Its U.K. grocery market share of 30% is roughly double its rivals: that's not sufficiently dominant to give it pricing power, but it does enjoy better economies of scale. Tight consumer spending is a drag on sales.

Tesco has been the innovator in expanding its market to the non-food sector, convenience stores, online sales, banking and other services, and now, restaurants. Geographic diversification has been less successful, with a disaster in the U.S., and patchy results in Eastern Europe and Asia.

2. Performance
Tesco delivered rising sales and profits until operating profit crashed into reverse, from 4 billion pounds, to 2 billion pounds in its annus horribilis of 2012/13, when flat trading forced it into costly restructuring to defend its core market.

Nevertheless, it maintained its dividend, which has risen since at least 1992, with cover recently in the range of two to 2.5 times.

3. Management
Some would say CEO Philip Clarke was handed a poisoned chalice after taking over in 2011 from Sir Terry Leahy, who had forged Tesco's character over 14 years.

After delivering the company's first profit warning for 20 years, lifelong Tesco employee Mr. Clarke took hands-on management of the U.K. grocery business, and seems to be succeeding at getting it back on track.

4. Safety
Tesco has a strong balance sheet with net gearing of 50%, and interest covered seven times. A 1.8 billion-pound pension deficit is manageable, set against Tesco's 30 billion-pound market cap.

Cash flow is naturally strong, though the consolidation of Tesco Bank is a distortion, with a 1.2 billion-pound increase in customer loans showing as increased debtors funded by borrowings.

5. Valuation
Tesco's prospective price-to-earnings (P/E) ratio of 11.4 is broadly in line with industry laggard Wm. Morrison, and cheaper than J. Sainsbury, while its 4.1% yield is a tad below the others.

Since its profit warning, Tesco's shares have traded at a lower P/E than at any time since at least 1994. The market is not yet pricing in full recovery.

Conclusion
With a dominant competitive position in its core market, and lots of new avenues for growth, there's much to find attractive about Tesco. To me, the shares look like a good value.

In fact, Tesco is one of the shares that the Motley Fool's analysts have picked out for a new report, "5 Shares to Retire On." The companies it describes have dominant market positions, healthy balance sheets, and robust cash flows, qualities that underpin their reliability and future dividends.

Whether you're saving for retirement or for any other purpose, I recommend you have a look. You can download the report by clicking here -- it's free.

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