Barclays upgrades Tesco to outperform

Apr 21 2008 by Andrew J Miller, The Journal

ASTRAZeneca – The firm has an evolving business model but we now have the added risk of potential generic challenges against two of its core five portfolio products.

However, we could argue that the current share price already discounts a significant part of this uncertainty, given that the shares are trading at the lowest P/E ratio in at least a decade.

There is undoubtedly higher risk associated with investing in AstraZeneca ahead of these challenges, we think that most investors are adopting a “wait and see” attitude, representing a good opportunity to pick up stock at the current low rating. We have lowered our estimate of fair value to reflect the tougher environment as well as the more stock-specific issues we mentioned earlier.

However, we still see double-digit upside to our earnings driven revised fair value of 2225p.

This positive view is supported by the top quintile rankings in our DDM.

National Grid – We continue to rate National Grid as an Accumulate and retain our DCF based fair-value estimate of 844p a share. Supported by the group’s long-term growth credentials, driven by the group’s substantial capital expenditure programme in its UK and US regulated networks, we retain our outperform recommendation.

National Grid predicts that it will invest an additional £12bn (gross) in its networks by 2012; this compares to the group’s market capitalisation (at 713p per share) of £17.9bn.

National Grid offers shareholders an attractive combination of a high dividend yield and strong dividend growth, supported by predictable cash flows derived from its infrastructure assets.

Rather like the 10% dividend growth the group delivered in 2007, the group has the potential to deliver dividend growth ahead of its underlying guidance of 8%.

Tesco – We are upgrading our recommendation on Tesco to outperform.

The shares have underperformed considerably since we downgraded them in November on fears the brand had become stale in the UK, and US expansion has not been going according to plan.

The management has reassured sector analysts that non-food sales are progressing well. The US expansion has not been as smooth as Tesco hoped.

Sales densities are apparently well below internal targets and news that Tesco now plans a three-month pause in the expansion has done nothing to calm investor nerves. Though we concede the US expansion represents a potentially attractive future avenue of growth, investors would do well to remember that this is a start-up business and, even if it achieves group targets in three years’ time, will still only be contributing 0.5% to group profits.

We have trimmed our DCF based fair value to 465p to reflect a higher cost of debt, as well as a more cautious view on the UK.

However we see sufficient upside at the moment to be adding to holdings in Tesco, a view supported by the fact that the shares currently trade at a 10% discount to their historic average P/E relative to the FTSE All Share.

Andrew J Miller, Regional Centre Head – Barclays Wealth