The strengthening consumer outlook will only push this surging stock higher

A strong competitive position suggests to Questor that this retailer remains undervalued

Tesco is extremely well placed to capitalise on an improving consumer outlook. The company’s recently released interim results showed that it gained market share in the UK, with its ongoing investment in pricing and product quality continuing to pay off.
Although inflation could yet tick higher in the coming months after falling to just 1.7pc in September, it is ultimately set to remain within touching distance of the Bank of England’s 2pc target over the coming years. This means that the era of rampant price rises is now over. 
Alongside impending interest rate cuts, with Base Rate due to fall by roughly 120 basis points by the end of 2026, consumers are set to experience a period of increased purchasing power. This should mean they become less price-conscious when buying groceries and other items, thereby allowing retailers such as Tesco to enjoy higher profit margins over the medium term.
While the FTSE 100 member’s sales rose by a rather pedestrian 4pc in the first half of its financial year, its earnings-per-share moved nearly 24pc higher. This was partly due to a 30 basis point increase in its retail operating profit margin, which amounted to 4.5pc during the six-month period, as well as the impact of an ongoing £1bn share buyback programme that is due to conclude in April next year.
The company plans to use most of the proceeds from the recent sale of its banking operations to fund an additional share buyback programme. Given that the firm’s shares currently trade on a price-to-earnings ratio of 15.2 and its bottom line is forecast to rise at an annualised rate of 11pc over the next two financial years, it offers good value for money. This means the company’s decision to repurchase its shares is sensible.
A stronger-than-expected financial performance in the first half of the year prompted a modest upgrade to the firm’s near-term guidance. It expects to post retail operating profit of around £2.9bn for the full year versus a previous forecast of at least £2.8bn. 
This naturally caused a degree of excitement among investors, with the company’s shares having risen by 50pc since this column initially advised readers to buy them around seven years ago. This represents a 41 percentage point outperformance of the FTSE 100. As an aside, the retailer’s shares are up 23pc since being added to our income portfolio in April this year.
On the topic of shareholder payouts, the firm raised interim dividends per share by 10.4pc. Although the stock currently yields a rather humdrum 3.4pc following its recent rise, further strong growth in profits should be passed on to investors via a brisk increase in shareholder payouts. Dividend cover of around 1.9 further highlights the income opportunity that is still offered by the company’s shares.
In terms of capital growth potential, Tesco’s 34pc share of the UK online grocery market means it is well placed to capitalise on a resurgence in digital sales. After a somewhat tumultuous period for online retailers following the pandemic, when a renewed enthusiasm for bricks-and-mortar stores emerged, digital sales as a proportion of total UK retail sales are consistently increasing year-on-year. 
The firm’s high degree of customer loyalty could act as a further catalyst on its financial performance and share price. Over 23 million UK households have a Tesco Clubcard, which means the company may be better placed than its rivals to gradually expand profit margins via price rises. A competitive advantage derived from loyal customers also provides a more stable financial outlook as the full impact of interest rate cuts takes time to be felt.
While the company’s net gearing ratio of 98pc is relatively high, net interest costs were covered a comfortable six times by operating profits in the first half of the year. This evidences a solid financial position from which to reinvest for growth as well as reward shareholders through additional share buybacks and dividends.
Given Tesco’s upbeat future prospects, improving competitive position and undemanding valuation, it continues to merit purchase. This column expects it to deliver strong capital growth, an attractive income and FTSE 100 index outperformance over the long run. Keep buying.  
Questor says: buy
Ticker: TSCO
Share price at close: 3561p
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