Ignore the hubbub, Tesco can still be a major income play

Investment insider

So Tesco's crown as the UK's most successful retailer has slipped. The past quarter brought the first fall in UK profits for decades and headlines this week cried out that the once mighty retail juggernaut has been stopped in its tracks.

But wait a minute, there is still a case for Tesco and the other "Big Four" supermarkets – Asda, Sainsbury's and Morrisons. The £160bn UK food retailing market is dominated by these four – which account for about three-quarters of the groceries we buy.

In comparison, the likes of Waitrose, together with Aldi and Lidl, account for less than 10 per cent of the market. For supermarkets, market share is vital. That is why Tesco's profit- slip has been greeted with such catcalls. But remember its share is still close to 30 per cent – that's an outstanding achievement over the long term.

The aim of all the players is to grow their market share in an otherwise slow-growth sector. This is understandable, as the grocery sector has grown only around 4 per cent a year since the turn of the millennium. Every little helps, as the advert says.

In terms of performance, supermarkets are by-and-large reliable. Over the past 12 years, the food and drug retail sector has delivered a total return of about 140 per cent, even though the shares have appreciated by only 65 per cent. The reason is that reinvested dividends helped to boost the total return.

In that sense, grocers should be seen primarily as income generators rather than fast-growing businesses. However, the simplistic income model was put to the test when Tesco embarked on an aggressive growth strategy in 2000 that almost doubled its share of the UK market over 10 years.

Even in its pursuit of growth, Tesco has been able to maintain its dividend track record – which now stands at 30 consecutive years of increased payouts.

What we have seen is that Tesco's aggressive growth strategy has come to a standstill, if not been sent a touch into reverse. But who is to say that this retail giant won't come again soon. As for the other members of the Big Four, Tesco's loss is undoubtedly going to prove their gain.

All in all, despite the negative headlines and the unprecedented fall in profits income-hungry investors write off the likes of Tesco and the other supermarkets at their peril.

David Kuo is director of the financial advice site fool.co.uk