Acquisition offer shows that Tesco is undervalued, Jefferies says

Given that it was a third-party that approached Tesco, Jefferies believed that a sale was likely to succeed.

Furthermore, the potential transaction had served to underline just how undervalued Tesco's Asian operations were and led Jefferies to switch to a sum-of-the-parts valuation approach, with the latter driving its target price from 285.0p per share to 310.0p.

The mooted proceeds of the sale of up to $9.0bn would value Tesco's Thai and Malaysian units at about 14.0 times their estimated February 2020 earnings before interest, taxes, depreciation and amortisation.

Comparable transactions in the region had seen Metro China go for 12.0 times EBITDA and Carrefour China for more than 20 times operating earnings, while local peers were sporting multiples of around 17.0 times EBITDA, analysts James Grzinic and Frederick Wild said in a research note sent to clients.

Such a valuation also had implications for the remainder of the group, they said.

"A target Asian valuation of >£6.5bn is a chunky 25%+ of TSCO’s [enterprise value], implying a very stingy 5.3x EV/EBITDA (pre-IFRS16) for the remainder of the group."

Grzinic and Wild estimated that a sale would generate net cash proceeds of approximately £6.0bn for Tesco's shareholders, driving the grocer's leverage from 2.7 times its EBITDAR to 1.6.

"With no obvious internal competing uses for this capital, shareholders should reasonably expect very sizeable exceptional distributions," they added.

As an aside, the two analysts also said that the latest UK opinion polls ahead of the general election were pointing towards an improved consumer backdrop in the UK.

Jefferies's recommendation for Tesco's shares remained at 'buy'.