Tesco Valuation

Aim of the report

The aim of the report is to use different valuation techniques to see if the current share price of Tesco plc is fair, undervalued or overvalued. Some of the findings will be compared with other firms in the same industries and share holders will be informed on whether they should buy, hold or sell.

Background information on Tesco

Tesco is the largest supermarket retail chain in the United Kingdom with Sainsbury being their closest rival. It is also the third largest retail chain in the world. In the beginning Tesco started off by selling basic groceries before diversifying into many different markets. In 2007 Tesco was operating in the following fields:

• General groceries

• Personal banking

• Fuel

• Telecom

• DVD sales and rental

• Clothing line

By the end of 2007 Tesco were operating in the following countries:

• China

• Czech Republic

• France

• Hungary

• Republic of Ireland

• Japan

• Malaysia

• Poland

• Slovakia

• South Korea

• Thailand

• Turkey

• United States of America

At the end of 2007 Tesco had a UK market share of over 30%, which is more than both Asda’s and Sainsbury’s market share combined. Tesco are continually trying to open up more chains around the world with aim of increasing market share. Tesco’s usual market strategy involves taking over failing retailers and then turning them profitable with their marketing experience and range of products.

Factors affecting the valuation

�Undoubtedly, valuation in practice involves considerable guesswork’

Smullen, J, p 278, 2007

The quote above refers to the fact that it is unlikely for a valuation to be correct. This is because forecasts of future revenue and expenses are all predictions using the information from previous years. Unforeseen circumstances might arise which may have a huge affect on the valuation. Or if one of the percentage rate chosen is a little wrong this may also change a company from being undervalued to being overvalued.

However this report will aim to create a reasonable valuation with all the information available, assuming information available is accurate.

Below are some important figures used in this report:

• Risk free rate on the 29/1/2008 (Bloomberg) вЂ" 4.59%

• Beta figure for Tesco on the 29/1/2008 (Bloomberg) вЂ" 0.735

• Risk Premium on the 31/12/2007 (Barclays) вЂ" 4.2%

There are some differences between the risk premium figures between different websites. The Barclays figure was chosen because it’s more in line with the historical trend.

Another critical factor which should be taken into account when reading this report is the time differences of certain parts of the report. For example the Earning based valuation figures are from different periods for each company. In reality this will have an effect on the stock price but for this report it will be ignored for the sake of comparisons.

Net Asset Value and Market Value

Net Asset Value:

Tesco’s NAV as at 24/2/2007 is Ð'Ј10571 million.

This figure is the equivalent of the shareholders fund in Tesco.

Market Value:

Current share price * Number of shares = Market Value

Market Price for share at 24/2/2007 = 432.00 pence

Number of shares as at 24/2/2007 = 7936 million

Market Valuation = 432.00 pence * 7936 = Ð'Ј34283 million

The difference in the two valuation method shows that Tesco is overvalued by Ð'Ј23712 million. The NAV share price is 133.20 pence.

NAV shows how much money the shareholders will receive if their business is discontinued. This seems like a fair method of calculating because the figure only states what the business is worth to the owners. However there are problem with using NAV as an indicator of value. The NAV does not take into account the future earnings of assets measured. This is the primary reason why there is a large difference between the market value and the NAV. For this reason net asset value should not be used as the primary indicator as the valuation of a firm.

The market price of a share is also subject to change everyday depending on a firm’s future prospect. For example Tesco’s current share price is 446.00 pence however if the competition commission announces that Tesco’s will not be able to expand at the current rate because of fears of a monopoly arising, this will have a negative effect on their share price because their future growth rate will slowdown. There are many other factors that will have a say in a firms share price. All of which can have an effect on a share price if there is a slight change in their figures or prospects.

Earning Based Valuation

Price to Earnings Ratio (PER) refers to the fact how long a shareholder has to wait to recover the cost of purchasing the share. PER is directly affected by the market valuation of a share. Tesco has a PER of 18.1p in the year 2007. This