How Tesco Measures Up as a GARP Investment

LONDON -- A popular way to dig out reasonably priced stocks with robust growth potential is through the "Growth At A Reasonable Price," or GARP, strategy.

This theory uses the price-to-earnings to growth (PEG) ratio to show how a share's price weighs up in relation to its near-term growth prospects -- a reading below one is generally considered decent value for money.

Today, I am looking at Tesco  (LSE: TSCO  ) (NASDAQOTH: TSCDY  ) to see how it measures up.

What are Tesco's earnings expected to do?

Metric  2014 2015
EPS Growth 1% 5%
P/E Ratio 10.6 10.1
PEG Ratio 15.9 2.1

Source: Digital Look.

Tesco is expected to recover from last year's 11% earnings per share dip with a slight recovery in the year ending March 2014. And City analysts expect earnings to enjoy a sizable bounce-back in 2015.

The slight earnings improvement expected this year still results in a chunky PEG rating, while next year's calculation -- albeit substantially improved -- still comes in above the benchmark of one. The P/E rating is more encouraging for this year and next, however, although for 2014, this still comes in on the wrong side of my desirable benchmark of 10 -- I consider any reading at or below that level to be stellar value.

Does Tesco provide decent value against its rivals?

Metric  FTSE 100 Food & Drug Retailers
Prospective P/E Ratio 14.9 65.5
Prospective PEG Ratio 4.5 7.2

Source: Digital Look.

Tesco's weak earnings recovery leaves it looking particularly deficient versus the FTSE 100, as well as its sector peers in terms of a forward PEG rating, although the firm's P/E rating is far more delectable versus both of these groups.

However, the readings of a handful of firms in the food and drug retailers sector distort the picture somewhat, so a comparison with supermarket rival J. Sainsbury is a worthy exercise. The latter currently trades on a higher prospective P/E rating of 11.4, although a lower PEG reading of two indicates its superior near-term growth prospects compared to Tesco.

U.K. struggles continue, but bright spots on horizon
Last week's interims underlined the quandary Tesco continues to suffer in its key domestic markets. Total U.K. sales, excluding petrol, rose just 1% during the thirteen weeks to May 25. And, like-for-like U.K. sales dropped 1% during the period.

The supermarket saw food demand pick up during the quarter, even though the horsemeat scandal dragged on demand for the firm's frozen foods and chilled ready meals. However, the fall in like-for-like sales was mainly attributed to ongoing weakness in general merchandise.

A difficult retail environment, and mounting competition from the likes of Sainsbury's, Waitrose, and Lidl threaten to keep earnings under pressure for the immediate term. Still, the company saw some encouraging drivers for long-term growth during the period -- total sales in Asia rose 10.9%, even though regulatory issues in Korea surrounding opening hours drove like-for-like transactions down 3.8%.

On top of its lucrative opportunities in international markets, Tesco's online business at home continues to grow strongly, while the group is also on track to grow the number of its more profitable Tesco Express outlets by more than 100 by the end of 2014.

I believe the firm has both the bulk and the know-how to turnaround its troubled U.K. businesses, although the likelihood of more short-term shocks could make it too risky for some investors.

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