Tesco

I thought I'd take a detailed look at Tesco.

Current price: 318p
EPS in 2008: 27p
EPS year-on-year growth: ~16%
Dividend in 2008: 10.9p
Dividend payout ratio: ~40%
ROCE: ~12%
ROE: ~16%

So 60% of earnings are reinvested at about 16% rate of return. That accounts for ~9% of growth. About 7% seems to come "free" - but are they just gearing up?

In 1999 they had debt of about £2bn, vs net assets of £4.3bn. In 2008 they had net assets of £12bn, but borrowings of £8bn. And £1.7bn in cash, so really only £6.3bn. So actually gearing has remained pretty static at 50%.

So this company has grown earnings per share at about 15% sustainably and is paying a 3.4% dividend. That's a total retun of 18.4%. Current P/E is under 12, whereas a safe company with such strong growth would normally command something like 15-20.

Even if we assume that organic growth moderates to 3% (i.e. only just keeping pace with inflation), you're still looking at dividend growth of 10% per year.

Refinancing debt may be more expensive in the future. Each 1% increase in finance costs equates to £80m off their pre-tax profits, which in the context of £2.8bn of pre-tax profits is not a problem.

This company has huge advantages:

• A stupendous growth record.
• Very strong cash flow.
• Low debt in the context of their massive earnings.
• A dominant position in their main market.
• Huge opportunities to export their business model abroad.

Concerns are:

• Growth will be difficult since it is so dominant in the UK.
• Economic conditions will hurt it, especially in the short run.

On the whole I'm struggling to find too many negatives. I'm convinced - I'll be looking to add some Tesco shares to my portfolio over the coming months.