Robbing Peter to pay Paul

Tesco released their first half results this week and the market liked them. Underlying earnings per share were up 17% and the dividend was upped 14%. The share price shot up over 5% as a result but I cannot make sense of the current valuation. The problem is that the business is not really growing at 17% but at 10%. The EPS growth includes profits from sales of their property portfolio which Tesco then leases back.

Tesco plan to sell a whole chunk of its property and use the profits to buy back shares and increase dividends. It sounds nice and certainly helped the share price but is it really such a win? What would happen if Tesco sold all its property and used the money to buy back shares? The share count would be less, the assets would be less and the profits would be less as Tesco would then have to pay rent for its stores. So everything would be smaller.

As a retailer you need property. Whether it is best to own it or rent it is up for debate. But I do not think releasing the value in your crown jewels is such an exciting move.

So back to the valuation. If Tesco is growing at 10% and has 100p per share in assets and is going to make 24p per share this year then the valuation could be

(24 * 10) + 100 = 340p

Maybe Tesco is worth more because of its defensive qualities and the fact that the rapid growth overseas may gradually result in overall growth accelaration as it become a bigger proportion of the pie.

So maybe Tesco is worth 400p. But it is currently at 460p so I will remain a share price observer for now.