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Tesco (LSE: TSCO) shares have stealthily outperformed the FTSE 100 over the past couple of years. In fact, since reaching a low of 200p in October 2022, they’re up 70%!
That return doesn’t even include dividends, which Tesco shares are primarily bought for. So, should I buy some for my ISA to aim for passive income? Here are my thoughts.
Still top dog
At first glance, I think there’s a lot to like about the company from an investing perspective.
For a start, it continues to rule the UK supermarket scene, despite relentless competition from the German budget chains (Aldi and Lidl) and stalwarts like Sainsbury’s and Asda.
According to the latest industry data from Kantar, Tesco’s sales rose by 4.6% in the 12 weeks to 3 November. This took the firm’s market share to a commanding 27.9%, up 0.6% on last year.
As a Tesco customer, I find great value in the Clubcard. Indeed, scanning it is almost like a national ritual.
Recently, I overheard a woman at the checkout insisting quite forcefully that her partner locate their Clubcard to avoid missing out on points. “Every little helps,” he said somewhat sarcastically as he located the card.
This little interaction demonstrated to me the level of brand loyalty and mindshare among Tesco customers. That would be very difficult for competitors to overcome and disrupt.
I also like Tesco’s leading position in the convenience store sector, strengthened by its ownership of food wholesaler Booker. This 2018 acquisition gave it exposure to a vast network of independent convenience stores, including Premier and Londis, in addition to its own Tesco Express and One Stop shops.
Passive income potential
Last year, Tesco raised its dividend 11% to 12.1p per share. This year, it’s expected to increase another 10%, bringing the total payout to 13.3p per share. These are healthy hikes.
For the next financial year, City analysts expect the distribution to rise to 14.5p per share. Now, that’s not a cert to come to fruition, as analysts can be wrong and dividends aren’t guaranteed.
However, it’s worth noting that Tesco is expected to earn around 28.7p per share next year. Therefore, the dividend cover is approximately two times. This means the company is expected to earn twice the amount needed to pay its dividend (14.5p), which is considered healthy coverage.
At the current share price of 345p, that translates into a forward dividend yield of 4.2%. It means I’d need about 6,900 Tesco shares to aim for £1,000 in annual passive income next year.
A tricky situation
Unfortunately, those shares would set me back around £23,805. That’s certainly more than I’ve got knocking about in my ISA.
And there are risks here. The main one I see is the increase in national insurance (NI) contributions for employers, starting in April, which could be inflationary.
Tesco is the UK’s second largest employer, with approximately 300,000 employees. According to Morgan Stanley, the NI increase will cost the firm £1bn over four years.
Of course, it could offset this with price rises, but it’s also committed to keeping costs low for customers. I fear this challenge could weigh on the share price.
Given this, I’m not going to invest in Tesco. But if the share price starts heading lower, I’ll reconsider my decision.
