The ASDA Threat Is Over

The Tesco share price (LON:TSCO) has hit a decade high, and so has its UK market share. With previous concerns surrounding ASDA now evaporating, the question now turns to whether the shares still have upside on a fair value basis.

Making a Basket Case Out of ASDA

Shareholders were spooked earlier this year when key competitor ASDA unveiled its plans to launch aggressive rollbacks to its prices. This subsequently led to the Tesco share price sinking by as much as 15.3%. But those who had conviction in Britain’s largest grocer and bought its shares at the bottom would have secured a lofty gain of 34.8% in less than 4 months – outstripping both the FTSE 100 (+16.1%) and S&P 500 (+22.6%).

Investors had initially feared that ASDA’s undercuts would lead to market leaders Tesco and Sainsbury’s having to lower prices to an unreasonable point in order to maintain their market shares. This would have come at the expense of their margins and profits. Tesco’s board were even spooked by the move, as they guided for a conservative EBIT range of £2.70-3.00 billion when they unveiled their FY25 results, which was reiterated in the Q1 update.

Thankfully, however, ASDA’s threats have failed to materialise thus far. As a matter of fact, the results have been quite the opposite, with Tesco seeing its biggest UK market share gain this year (+0.8%), while ASDA continues to lose ground (-0.9%). Moreover, the latest Kantar data recorded Tesco sales rising a whopping 7.4% – almost double the market’s 4.0%, while ASDA’s sales remain in negative territory (-2.6%).

So, what gives? Well, ASDA’s underwhelming rollbacks can be attributed to a couple of main points. The first is that many of its items – despite having decent price differentials of around 3.0-5.0% – have mostly involved non-core items. These include products such as toilet paper, bathroom gels, baby products, etc. which don’t move the needle when it comes to true price perception. What’s more, many of these promotions have also lasted shorter than expected.

Secondly, the point Tesco CEO Ken Murphy has been driving home over the last few earnings calls is showing up in the data – consumers focus on more than just value. They’re looking for a full shopping experience, and it should go without saying that Tesco has managed to refine its shoppers’ experience through better packaging, deals, store retrofits, digital experiences, and a rewarding loyalty scheme – areas where ASDA has fallen short in.

Rolling Back on Market Share

As such, I have strong reason to believe that an imminent upgrade to FY26’s EBIT will come to fruition when Tesco unveils its half-year results in October. Market consensus is still lingering on the side of caution with an EBIT of £2.96 billion, marking a 5.2% drop from last year. However, I’m more optimistic with my more upbeat projection of £3.12 billion, which marks a less pronounced 0.3% decrease.

There are several reasons behind my estimate. First and foremost, although ASDA still seems adamant to undercut its competition having refinanced the bulk of its debt to the 2030s, it still has a hefty debt pile of £4.60 billion. With ratings agencies such as Fitch downgrading ASDA’s debt profile, the scale of rollbacks may lessen by Christmas if sales don’t improve, as the firm may not want to risk further rating downgrades or liquidity strains.

Secondly, Tesco’s market share gains keep widening. Whilst I was initially wary of decelerating sales growth as a result of industry competition and a worsening macroeconomic outlook stemming from higher unemployment and declining real wage growth, the data has suggested otherwise. Tesco’s consumers are still trading up to branded goods, with premium-line items making up a bigger proportion of customers’ baskets.

And while branded goods are seen to be more margin dilutive, I have conviction that the trading up activity will flow through to margin-accretive own-brand sales as well. This should offset the margin losses in the former. After all, a hefty chunk of branded promotional items are still being funded by suppliers, which gives a form of margin cushion.

More promisingly, grocery inflation looks to have peaked as well, with August’s release seeing the first deceleration since January. This is most likely due to the fact that much of the recent price increases have been a result of administered labour price hikes rather than underlying food supply costs. In fact, four of the top five key commodities which tend to be leading indicators for grocery inflation, have been disinflating/deflating in price.

Fine Margin for Error

As a result of the factors discussed, I believe Tesco would not have to employ as much capital as it initially intended to in order to lower its prices and compete with its peers. Hence, I’ve estimated Tesco’s FY26 EBIT margin to come in at 4.28% – 18bps higher than the market’s current consensus of 4.10%. This is, however, contingent on no further tax/administered wage hikes or supply shocks coming into play between now and next year.

Alongside this, I’m also anticipating the company to complete its £1.45 billion share buyback programme before the end of its financial year in February, given the rate of buybacks I’ve observed. The group is approximately £100 million ahead of my initial estimated timeline. Therefore, this should serve as a small tailwind for EPS come the end of the year.

Having said that, in spite of the stellar performance and better outlook, I have reason to believe that the Tesco share price is fairly priced by my estimates. Currently, I have modelled for the conglomerate to grow at a CAGR of 10.65% through to FY28, with EPS hitting 35.09p by then – 5.8% above the mid-range of consensus. This will be primarily driven by continued market share gains, bigger baskets, and further trading up momentum.

Despite that, this only brings Tesco’s PEG to 1.5 – not too far behind the stock’s sector and historical average of 1.6. Its FP/E of 13.6 is also bang in line with its comparable average of 14.6, which doesn’t leave much room for upside from a fair value perspective. Ergo, given the macroeconomic uncertainties and the relatively lofty expectations the retailer will have to achieve, I believe the stock is priced to perfection at its current level.

That being said, I wouldn’t sell the stock, as Tesco has shown the potential to outperform with upside surprises. Even so, any further upside will warrant stronger market share gains, which may be difficult as share grabs become more saturated given the current micro and macro environment. Thus, that I have a fair value target of 440p for the Tesco share price.