Citywire for Financial Professionals
Stay connected:

View the article online at http://citywire.co.uk/money/article/a638353

Smart Investor: bad-mouthed Tesco is a bargain

Ahead of a third quarter trading statement on Wednesday, our columnist explains why – contrary to popular opinion – Tesco is financially sound, highly profitable and very cheap.

 
Smart Investor: bad-mouthed Tesco is a bargain

Tesco is rarely out of the media headlines. Whether it is a columnist in a newspaper complaining about the ‘Tescopoly’ that is today’s food retailing industry, a local community which does not want a Tesco on their doorstep or a family which has found a dead frog in their Tesco salad, the company is always written and spoken about.

Fall from grace?

This year, much of the talk has focused on Tesco’s ‘fall from grace’, where profit growth has slowed (and disappeared for the first half of the current financial year) amid difficulties with the company’s US division and a lack of growth in its main market of the UK (which accounts for two-thirds of revenue ). Of course, exponential growth is impossible to achieve so, with shares now priced at £3.22, is FTSE 100-listed Tesco (TSCO.L) a worthy addition to your long term portfolio?

Jack Cohen founded Tesco in 1919 when he opened a market stall in East London, with his first product being Tesco tea. Since then the company has made a number of acquisitions, listed on the stock exchange over 65 years ago and pioneered the superstore outlet in the UK. Today, it trades in 14 countries, employs 500,000 people, serves millions of customers each week and, with a market capitalisation of £26 billion, is the 20th biggest UK listed company.

Impressive numbers

With all of the negativity in the UK media surrounding Tesco’s performance in recent years, you could be forgiven for dreading taking a glance at the P&L (profit and loss statement). However, Tesco has performed well and has delivered a net profit in each year, with the bottom-line growing at an annualised rate of 8.2% over the last five years.

Indeed, net profit of £2.8 billion in the year to February 2012 equates to a return on equity (ROE) of 15.8%, with ROE averaging 16.5% over the past five years. This is highly impressive, both when compared to Tesco's FTSE 100 peers as well as to sector peers. Clearly, Tesco is highly profitable and is performing well. Sure, profit growth may prove to be lacking in the current financial year but this is partly due to lower pricing and, as a result, lower margins. In any case, ROE is likely to remain impressive.

With shares having fallen from £4+ to their present £3.22, Tesco currently yields 4.6% from a payout ratio of 42%. This is a sensible payout ratio as it leaves the bulk of profit available to reinvest in the business but also means that the company ticks the income box, making it attractive for income seeking investors. Interestingly, Tesco is the 18th highest yielding stock on the FTSE 100.

As for its balance sheet, Tesco’s debt levels remain moderate, with a debt to equity ratio of 66%. This, combined with attractive levels of profitability, mean that interest cover is comfortable at 7.3. Clearly, Tesco is not posting such rich ROE figures via exceptionally high levels of borrowing.

Indeed, Tesco’s ability to generate such returns – even during challenging economic times – indicates that it has a generous economic moat. It appears to have a large degree of customer loyalty through being perceived as offering significant value for money, has an exceptionally efficient supply chain, a very low cost base, a more diverse revenue stream (in terms of geography) than rivals and also enjoys substantial barriers to entry.

Knock-down bargain

Furthermore, with shares currently priced at £3.22, Tesco trades on a price to earnings ratio (P/E) of just 9.2 and a price to book ratio of only 1.5. Both of these figures show that shares are cheap at current levels, especially when the quality of the company is taken into account.

Of course, Tesco may not be a company whose products you purchase. It may not even be a company you particularly like. However, from a purely investment perspective, it is financially sound, highly profitable and very cheap at current levels. Regular readers will know that I consider myself to be a value investor who likes to use cost averaging when buying and selling shares. Tesco shares offer excellent value for money and are well-worthy of cost averaging, with shares being more attractive now than when I last wrote about the company.

Smart Investor holds shares in Tesco. Smart Investor last tipped Tesco on 20 July 2011. Since then, shares have delivered a total return of -14.3% versus 4.7% for the FTSE 350 over the same period.

33 comments so far. Why not have your say?

Deacon

Nov 30, 2012 at 15:16

Absolutely first class summary of the current position

report this

McDonji1

Nov 30, 2012 at 16:16

Do I get Clubcard points if I buy shares? Jim

report this

Simon Taylor

Nov 30, 2012 at 16:35

The easy way to value any company is to monitor the amount of vitriol it attracts from left wing panellists on Question Time and Guardian columnists.

On this fail safe investment method, Tesco is a raging buy.

report this

SJB

Nov 30, 2012 at 16:41

Tesco might be financially sound but Tesco Direct is a shambles. If you try to buy goods on-line with vouchers it rejects the transaction. I then phoned their Customer Services and, having entered my order, they discovered that vouchers were not being accepted. This has been going on since last Wednesday, that I know of.

report this

PedroKTFC

Nov 30, 2012 at 16:52

Managed to use vouchers last night!

report this

keith21250

Nov 30, 2012 at 17:07

It is not the profit or success to date which concerns investors, it is the fact that even if Tesco new plan is a success and gets the company back into the position it wants to be in, the cost of doing this will destroy the margins. They plan ti employ new staff, refit the stores, put "apples back into apple pies" and lower the prices. When they have finished, what will be left for the shareholders.

Another grass roots comment comes from visiting lorry drivers who say the stores and warehouses are much quieter than they used to be. Difficult to confirm this but comments from the shop floor are always worth noting.

report this

W D Morris

Nov 30, 2012 at 17:26

Don't bank on "large degree of customer loyalty "

My local Sainsbury's is packed today (Friday). The local Tesco's, a couple of miles away, is fairly busy but with nothing like the crowds.

Tesco's have been trying so hard to hoodwink their customers for so long with their 'special offers' that they have been found out. All the supermarkets do it, but the loss of confidence is Tesco's alone so far.

It will take years to retrieve their reputation and they show no signs so far of even understanding the problem. e.g. a bag of bananas, special offer in a bag for £1, weighed on the checkout as loose - 80p. The lack of people in the aisles is bound to push through to the SP sooner of later.

report this

Malcolm Hayden

Nov 30, 2012 at 17:39

Difficult to comment on the success of the Tesco investment policy at this time of year - people are beginning to stock up for Christmas. I have noticed that the the car park at my local superstore is not so busy, also they appear to have cut the points you get when buying petrol/diesel. Time will tell after the Christmas panic

report this

Michael Mason-Mahon

Nov 30, 2012 at 18:05

Great article but one thing you may consider what is the out look for this company? Customer Service is very bad, I have been able to meet and talk to a great number of staff and they do raise very serious concerns about the behaviour of the company.

I do think they Board has lost their way for years, their CEO HAS MISSED GREAT CHANCE's.

I do think that staying open till 22:00 on Christmas Eve is a VERY BIG Mistake,

I do think 17:00 is long enough. On this one day is should be STAFF BEFORE PROFIT NOT PROFIT BEFORE STAFF.

They have 364 days to make their profit, please show some respect for your staff and let them have a family Christmas.

I would recommend that you try and avoid their Southwark Store, I do think that there is so much more Philip Clarke can do with Tesoc.

It can become a Great British assets, will they ?

report this

Striker

Nov 30, 2012 at 18:36

Have bought, still own and will buy more shares. Tesco - British and proud of it. One of our Greatest whether you like 'em or not!

report this

JEL G

Nov 30, 2012 at 19:02

Tesco have done me extremely well since I bought my first 3K's worth back in 1980.

The return on my capital in the form of net dividends is measured in three zeros percent !

Lovely retirement income...........

report this

Dennis .

Nov 30, 2012 at 19:07

Just bought another £2K worth yesterday.

report this

Olwin

Nov 30, 2012 at 20:18

Have just got back from a long holiday and delighted to see the shares so low . They have served me well over the years . On Monday I will be adding quite a few more . Customer service - have never had a problem .

report this

Franco

Nov 30, 2012 at 23:15

The days of rapid growth are over, Tesco now is too big to run fast. Give her a walking stuck.

report this

Eugen

Dec 01, 2012 at 05:49

Useless article. Tesco is losing market share by the minute. All its competitors are positioned better than Tesco.

The management is useless. Has any of you calculated the return on the money Tesco is reinvesting? It is negative so better it should distribute them to their shareholders as dividend rather than reinvesting.

People with money order their groceries at home so their shops become reduntant. This is the type of clients Tesco used to make a margin on. This market shares was taken by others. On my street we all get deliveries at home but non buys from Tesco. I haven't seen a Tesco delivery on my street for more than 1 year.

As investor you need to see the new paterns emerging and at this moment clients are moving in droves from Tesco.

report this

snoekie

Dec 01, 2012 at 17:01

I am only a recent Tesco owner, @£3.15, and am waiting for levels to drop again. A few years ago I waited to buy in @£2.60, hoping for cheaper and had to settle for Morrisons, when TSCO kept climbing.

Tesco is my local, 5 min walk, and over the years I have done well out of their on the day bargains, but they are becoming harder to get (but still get some great bargains (recently a top roast joint for £2.20), the local store has greatly tightened up on stock control, as well as doubling the price of the bargains, from 10% to 20%. As I am a regular, I might as well get more from my shopping there. Problem is now we have to compete with store staff and managers going around to the back and cherry picking what they want whilst the customers are kept at bay. Galling when on occasions I found stuff that the staff missed and a bl**dy manager grabs it.

They have tightened up on stock control, but the idjiots in the back room need to get their act together, because I still find small packs proprtionately cheaper than the larger packs. Customers are not stooooooooooooooopid, certainly not as they are. Only the other day, a "bargain" on their discounted section, a pack with a bottle missing was more expensive than a full pack. They need to tighten up on the quality of the backroom price deciders.

Plenty of room for improvements. Mind you, they are more commercial than M & S (in whom I also have shares), who do not discount their sell by date stock, and give it away. At least Tesco reduce their 'losses' by discounting and moving sell by date stock.

M & S are maximising their stock losses., 100% and make no effort to minimise their loss. Maybe someone/people should have a word in the top brasses shell likes, this way they are deliberately throwing away £10s of thousands in stock every day without even trying to mitigate the losses. Not a great way to run a business.

Mind you in this store there are quite a few gannets (I am one of them), but they do help to reduce the 'losses'!

report this

Michael Hellman

Dec 01, 2012 at 21:12

The figures may stack up but I have to like the product. My experience is one of really poor quality why would I buy shares in a company whose products I consider to be inferior to other supermarkets. Japan has also been cheap for years well decades actually, and there is a reason.

report this

doug186

Dec 01, 2012 at 23:30

Snoeki

As you own Morrison shares, I suggest you take every opportunity to go out of your way to buy goods from them too. Their all round offering of fresh vegetables,fruit and meat and fish is second to none. Furthermore their staff are helpful and attentive. Their shares are good value now for the long term.

report this

Dennis .

Dec 02, 2012 at 00:15

@M Hellman "why would I buy shares in a company whose products I consider to be inferior". The world is full of examples of "inferior " products that are very successful eg Microsoft and most of its products, VHS vs Betamax, IBM computers in the 80's, BMW overpriced cars etc.

A lot of people here are confusing investment decisions with personal preferences. Companies such as M&S and Tesco are, regardless of issues pointed out above, still very profitable companies and plus or minus a few percentage points in market share are unlikely to change very much.

report this

snoekie

Dec 02, 2012 at 00:34

Doug, true, but they a car drive away.7-10 min, as opposed to Shanks's pony, 5 min for Tesco, and I need the exercise!.

report this

Malcolm Hayden

Dec 02, 2012 at 07:41

I agree with Snoeki - to which I would add their Bakery. Not so sure about the shares though, they do not have the amount of choice for items other than food like Tesco and Sainsbury's. I am fortunate to have three of the big four within five minutes of my house - so I can compare quite easily, By the way we never hear anything about Kiddycare that Morrison bought for mega money !!

report this

Maverick

Dec 02, 2012 at 11:17

All you lot are using too much logic. It doesn't matter a sniff if the company is financially sound and highly profitable, and its shares are cheap, if the market as a whole doesn't like the company. No amount of selling up the company here or elsewhere will alter that.

You can't fight the markets, you have to run with them. Look at Tesco's share price graph, and tell me if you can see any signs of a sustained recovery.

Why do punters seem to be fixated about supermarkets and banks? Is it simply because those are the only parts of Big Business the punters have any regular contact with?

report this

Joe Z

Dec 02, 2012 at 13:21

The writer forgot to mention that there is a hidden value of C. £15 billion in property which hasn't been ever valued. This is according to Tesco 2012 Annual report. So at the current price of 325 the shares trade at 84% of the property adjusted net asset value. Several years ago when a similar thing happened with Sainsbury's, Kuwaiti investors tried to buy the whole company. I wonder if they will do the same here.

report this

normski 2nd

Dec 02, 2012 at 16:10

Yeah Joe Z they own a fair bit of land in my town too.

normski

report this

Matt via mobile

Dec 02, 2012 at 16:24

Will Tesco still be here in 10 years? Yes, I believe it will be. Will it be profitable? Yes, I believe it will be.

Huge prescence and part of British daily life. Looking at your local store's customer service as a benchmark of quality is short sighted.

The real growth over the next decade will be online shopping and home delivery. Tesco already have an infrastructure and are investing in dark stores.

Morrisons and Sainsburys maybe going well now but they have much less scope for growth.

My tuppence.

report this

JEL G

Dec 02, 2012 at 18:02

Well I receive extremely healthy and increasing dividends and have been from Tesco for well over 25 years now and most certainly will not sell !

report this

Michael Hellman

Dec 02, 2012 at 20:39

@Dennis. I repeat I have to like the product.

report this

Robert18

Dec 03, 2012 at 07:47

Matt could not agree more, I use the home delivery and have done for two years os so due to ill health and on onlt TWO occasions when I have had to ring the customer services I have found them very usefull and resolved my issues, I cant ask more than that and I know I keep on hearing my friends and neighbours taking up the home delivery option and the super saver on the delivery charge was a great idea, I will not only continue to shop with Tesco but also continue to buy their shares in what I believe is a very bright future for a great British company

report this

Richard Grime

Dec 03, 2012 at 17:09

I go back to first principles: yield 4.7% ,dividend cover of over 2 (2.4), low P/E, good economic moat, hugh landbank in the U.K. Competent management expanding into growing markets abroad. Established online. A First Class worldwide Company. I have only owned TSCO for a couple of months but will buy more if the price drops on Wednesday.

report this

Long Term Investor

Dec 03, 2012 at 19:34

No mention of the ivestment they are putting into their worldwide outlets. Up until now they have been losing money on these, but they are a very professional company and are learning fast how to adopt the very succcessful UK formula, whatever the naysayers think, and will be the world class grocery of the 2020's. My pension is safe.

report this

Eugen

Dec 04, 2012 at 13:04

A few fans of Tesco here but I am not. Falling in love with stocks is a big behavioral mistake and also very costly.

First people need to understand they are not Warren Buffett and they don't have the investing timescale of Warren. Warren wants to hold stocks forever, we can't afford that.

There is an interesting article today with Alastair Mundy. For people who don't know him he is arguably the best contrarian investment manager in UK of this time. He tells us why Tesco is not a 'value company' and it is not an investment idea. First Tesco needs to change their management says Mundy.

Neil Woodford from Invesco Perpetual High Income is another investment manager who sold the Tesco shares in January this year to Warren. And I know a few others.

Warren could force a change in the Tesco's management but he is not interested in this as he wants to buy more cheap Tesco shares. The current useless management play in his favor.

If you invest in Tesco you are in for a rough ride. More profit warnings are to come.

report this

Eugen

Dec 04, 2012 at 13:04

A few fans of Tesco here but I am not. Falling in love with stocks is a big behavioral mistake and also very costly.

First people need to understand they are not Warren Buffett and they don't have the investing timescale of Warren. Warren wants to hold stocks forever, we can't afford that.

There is an interesting article today with Alastair Mundy. For people who don't know him he is arguably the best contrarian investment manager in UK of this time. He tells us why Tesco is not a 'value company' and it is not an investment idea. First Tesco needs to change their management says Mundy.

Neil Woodford from Invesco Perpetual High Income is another investment manager who sold the Tesco shares in January this year to Warren. And I know a few others.

Warren could force a change in the Tesco's management but he is not interested in this as he wants to buy more cheap Tesco shares. The current useless management play in his favor.

If you invest in Tesco you are in for a rough ride. More profit warnings are to come.

report this

Dennis .

Dec 04, 2012 at 14:44

All I know is that people need to eat a couple of times a day, they can cut back on anything else but not food. Tesco might gain or lose a bit of market share but without their distribution network for agricutural output a large percentage of the population would starve.

Remember the old political saying that "we are forever only three meals away from anarchy".

Isn't food the ultmate defensive sector?

report this

leave a comment

Please sign in here or register here to comment. It is free to register and only takes a minute or two.

News sponsored by:

The Citywire guide to investment trusts

In association with Aberdeen Asset Management

Henderson Global Investors: 2014 looks set to be another strong year for UK commercial property


Andrew Friend, acting co-manager*, and Marcus Langlands Pearse, co-manager of the Henderson UK Property Unit Trust (HUKPUT), provide an overview of the key risks and opportunities for the UK commercial property market.

More about this:

Look up the shares

  • Tesco PLC (TSCO.L)
    Register or Sign in to receive email alerts for items in your favourites whenever we write about them

More from us

What others are saying

Archive

Today's articles

Tools from Citywire Money

From the Forums

+ Start a new discussion

Weekly email from The Lolly

Get simple, easy ways to make more from your money. Just enter your email address below

An error occured while subscribing your email. Please try again later.

Thank you for registering for your weekly newsletter from The Lolly.

Keep an eye out for us in your inbox, and please add noreply@emails.citywire.co.uk to your safe senders list so we don't get junked.

Read more...

Diary of a Dumb Investor: I'm Russian for returns

by Dumb Investor on Apr 17, 2014 at 15:01

Sorry, this link is not
quite ready yet