Tesco attracts fresh upgrade

It's not as ballsy as Morgan Stanley's upgrade earlier this week, but investment bank Espirito Santo, reckons Tesco is over the worst of its nightmare and believes its shares are now worth 265p, up from 165p previously. While this fresh support for Tesco is hardly uber-bullish - Espirito raises its rating from Sell to Neutral - it does at least hint that icy market sentiment toward the supermarket is beginning to thaw.

Espirito analysts admit that Tesco's road to recovery will be "long and winding", but they do believe the grocer's long-term credit facility gives it time to generate a meaningful recovery and avoid any punishing widening in spreads due to junk status.

"We think Tesco's decision to enter junk status in a tight high-yield market is a brave, perhaps risky, but probably correct decision; we think Tesco's credit facility gives it adequate time to reduce leverage and keep its valuable assets."

The collapse in oil prices should also make things a little easier for the supermarket, benefiting its out-of-town stores which have been struggling from an increasing number of customers turning away from the traditional big weekly shop to more frequent and local visits.

Valuation is, of course, a problem. "The market is assuming any level of margin and any level of outer year margin scenarios," says Espirito. "We think most numbers surrounding these are purely speculative. We present a normalised valuation base for Tesco assuming Tesco achieves a 3% EBIT margin and avoids any upstanding debt issues."

However, the investment bank is confident that Tesco is adapting to consumers' needs, cutting prices by 3% over the last three months. "Our recent store visits reflect a cleaner, sharper, more competitive and healthier Tesco offer. We think these moves represent a very good start and are more attuned to consumer trends."

Despite the good forecasts, Espirito isn't as bullish as Morgan Stanley, noting that the share's aggressive rerating sparked by its Christmas trading update on 8 January has priced in any near-term recovery, and the broker makes another interesting point. "Data from google show a large drop-off in interest in Tesco post its black Friday bounce. We think Tesco has scope to disappoint near-term vs. its sales performance achieved in December."

Tesco's accounts are still worrying the analysts, too. Highlighting the difference between Tesco's cash tax and cash interest and its P&L representations, Espirito expects full disclosure to benefit Tesco.

"The biggest change in the last three months has been the halving of the oil price. This has significant benefits for the brick and mortar food retailers in that it diminishes the impact of convenience and online shopping, as well as improves consumer disposable incomes."

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