Tesco is a 'visible turnaround', JP Morgan analysts say

Tesco is a visible turnaround story and the retailer will increasingly be viewed as a capital return stock, JP Morgan analysts said as they rated the shares ‘overweight’.

The supermarket chain’s recent acquisition of Booker is transformational because it gives Tesco a bigger market to aim at, more than £6bn of revenue capacity and a better mix of formats as shoppers opt for online and convenience, the analysts said. In addition to £200m of synergies, Tesco has secured the execution abilities of Charles Wilson, Booker’s former boss who has taken over as head of Tesco’s UK business.

The Booker deal, which is not reflected in consensus estimates, will allow Tesco to generate £4.4bn of free cash flow and reduce its net debt by £2.2bn by 2020, JP Morgan said. A quarter, or £1.1bn, of the free cash flow will be returned to shareholders in dividends, they predicted.

For this reason, investors will shift their attention to Tesco’s cash generation and ability to return capital and away from its trading potential, the analysts said. They gave Tesco a 265p price target compared with 210p at the time of publication.

“We turn buyers of Tesco shares for the first time in five years as its cash flow, top line and balance sheet have improved, whilst Booker adds new addressable market potential and strong execution capabilities with Charles Wilson now at the helm,” the analysts, led by Borja Olcese, said in a note to investors.

Better-than-expected execution is an opportunity, given the strength of the management team, while weaker revenue trends are the biggest risk, they said. A stronger Tesco is not good news for Sainsbury’s given their geographic and customer overlap, the analysts added.

Before Tesco's bid for Booker, JPM had an 'underweight' rating and a 135p price target on the stock.