Tesco Stock or Tesco Bonds – I know which Mr Buffett would prefer
Supermarket juggernaut Tesco released its latest bond issue last month. With maturity date of 24th August, 2018 the bonds are of a short to medium term. Currently trading at 103.75 with a yield of 5.20% it is worth questioning whether the bonds would be a stronger hold than Tesco equity.
The bonds are a fixed coupon type with a 6 month coupon frequency and, as far as I can gather, are the first bonds issued by Tesco Bank. It is these very bonds which are meant to finance Tesco Bank’s development and expansion.
Bonds are best utilized, according to Benjamin Graham’s ‘The Intelligent Investor’ when the equity market is at a high level. There is no dispute that the market, generally, is fairly valued after its second fastest ascend from a bear market low in history, the fastest ascent being the 30’s depression rally.
However worried regarding an inflationary environment dominate investors thoughts worldwide and from the same tome ( The Intelligent Investor ) we cull that superior investment returns during inflationary periods can be accomplished through stock investments.
Consider that on the London Stock Exchange I purchased Tesco stock at 392p. On current forecasts, that places the stock on a multiple of 10.89 for the year ending February, 2012. Given that the stock closed the 2009 financial year on its lowest multiple of 11.5 ( the second lowest multiple over the last 5 years being 13.2 for the 2010 financial year ) it seems that Tesco stock is undervalued due to short term fears ( bad winter weather, Japanese earthquake etc ). Bear in mind that Tesco is able to pass most food inflation costs onto the consumer.
The dividend yield on today’s purchase of Tesco stock comes in at 4.01% (based on a payout of 15.72p for the year ending February, 2012 courtesy of www.digitallook.com ). Not including the final dividend payment for year ending February, 2011, which I also qualify for (the stock goes ex-dividend in April), the stock returns an average yield of 5.27% if the dividend grows by 9% per annum. This is roughly similar to the bond yield.
Therefore we can focus on the bond premium. With a par of 100 and the bond trading at over 103 there seems little room for upside. Perhaps with demand it could trade up to the 115-120 range.
Importantly if earnings were to increase by a conservative 7% per annum then by year end February, 2018, the EPS would be 54p. Place this on a low to moderate multiple of, say, 12, and presto – our share price would be around 650p or a nice 65% increase on today’s purchase price.
I know which security Mr Buffett would choose.
Disclosure: Long Tesco
Supermarket juggernaut Tesco released its latest bond issue last month. With maturity date of 24th August, 2018 the bonds are of a short to medium term. Currently trading at 103.75 with a yield of 5.20% it is worth questioning whether the bonds would be a stronger hold than Tesco equity.
The bonds are a fixed coupon type with a 6 month coupon frequency and, as far as I can gather, are the first bonds issued by Tesco Bank. It is these very bonds which are meant to finance Tesco Bank’s development and expansion.
Bonds are best utilized, according to Benjamin Graham’s ‘The Intelligent Investor’ when the equity market is at a high level. There is no dispute that the market, generally, is fairly valued after its second fastest ascend from a bear market low in history, the fastest ascent being the 30’s depression rally.
However worried regarding an inflationary environment dominate investors thoughts worldwide and from the same tome ( The Intelligent Investor ) we cull that superior investment returns during inflationary periods can be accomplished through stock investments.
Consider that on the London Stock Exchange I purchased Tesco stock at 392p. On current forecasts, that places the stock on a multiple of 10.89 for the year ending February, 2012. Given that the stock closed the 2009 financial year on its lowest multiple of 11.5 ( the second lowest multiple over the last 5 years being 13.2 for the 2010 financial year ) it seems that Tesco stock is undervalued due to short term fears ( bad winter weather, Japanese earthquake etc ). Bear in mind that Tesco is able to pass most food inflation costs onto the consumer.
The dividend yield on today’s purchase of Tesco stock comes in at 4.01% (based on a payout of 15.72p for the year ending February, 2012 courtesy of www.digitallook.com ). Not including the final dividend payment for year ending February, 2011, which I also qualify for (the stock goes ex-dividend in April), the stock returns an average yield of 5.27% if the dividend grows by 9% per annum. This is roughly similar to the bond yield.
Therefore we can focus on the bond premium. With a par of 100 and the bond trading at over 103 there seems little room for upside. Perhaps with demand it could trade up to the 115-120 range.
Importantly if earnings were to increase by a conservative 7% per annum then by year end February, 2018, the EPS would be 54p. Place this on a low to moderate multiple of, say, 12, and presto – our share price would be around 650p or a nice 65% increase on today’s purchase price.
I know which security Mr Buffett would choose.
Disclosure: Long Tesco
