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Over to you Mr Lewis: is now the time to buy Tesco again?

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Over to you Mr Lewis: is now the time to buy Tesco again?

Tesco must be wondering how it fell from the dominant force in retailing to this.  

Once the pin-up of the stockmarket, the supermarket giant followed last month’s profit warning with yet another alert, compounding the pain by saying it will cuts its interim dividend by 75%.

Such is the urgency at the firm, it said new chief executive David Lewis would take the mantle a month early on 1 September.

He replaces Philip Clarke, who had presided over one of the most difficult periods in the firm’s 95-year history as low cost rivals such as Lidl and Aldi ate into its market share.

Figures published earlier in the week from research firm Kantar Worldpanel showed Tesco sales fell 4% in the 12 weeks to 17 August, the most pronounced fall of the big four supermarkets.

And things are set to get worse. In today’s grim update, Tesco warned 2014/15 profit could fall by as much as £0.4 billion. It said it would limit capital expenditure at £2.1 billion, some £0.4 billion more than originally planned.

Tesco took a fresh beating on the news, with shares down by 10% at one point during the day to hit an 11-year low of 222p. They have since recovered to stand at 236.65p. 

Tesco chairman Sir Richard Broadbent remained defiant. ‘The actions announced today regarding capital expenditure and, in particular, dividends have not been taken lightly,' he told the stockmarket.

'They are considered steps which enable us to retain a strong financial position and strategic optionality.'

Any bulls?

Once a core holding for fund managers, it is becoming harder to find Tesco bulls.

This small pool includes Investec Asset Management's Alistair Mundy (above), who said recently: ‘Having not owned the shares when they were very popular, we moved to equal weight and then overweight as sentiment has turned against the UK supermarkets.

He added: ‘Previously the darling of the sector, Tesco has struggled with its market positioning and despite its scale has suffered at the hands of both the discounters and the more premium supermarket players.

'With valuation now more attractive we remain believers that despite the short-term pain of a price war the stock will offer value over the long-term.’  

But with investors likely to lose an £800 million windfall from the dividend cut, why should investors remain loyal to a stock which is constantly disappointing?

Ardevora’s Jeremy Lang (above) is not so forgiving, implying the firm has an identity crisis.  

Lang said: ‘The issue for Tesco, as well as similar chains, is it tries to do everything: cheap food, expensive food, clothes, toys – but it ends up doing nothing particularly well.

‘The idea it can adapt its existing store base is wrong – it is wedded to its previous business model, which was extremely profitable in the past. However, the world is changing.’

He added: ‘Essentially, Tesco has been left with a legacy store base, which does not make sense given the new trends in the market. Our interpretation of how management is behaving through its balance sheet and investment decisions is that it is in a state of denial.’  

Buy now?

However, Cantor Fitzgerald is among those who saw today’s drastic action as a potential blessing.

The dividend cut mirrors that of the route taken by Sainsbury's in 2005, when incoming Justin King halved the dividend and Cantor, which has a buy rating on Tesco, with a 325p price target, believes competitors should now be wary as the firm clearly means business.

'A £800 million reduction in total dividend and £500 million cost base reduction would give Tesco £1.3 billion of extra cash to either invest in price and put its main competitors in considerable margin pain or build a new trading strategy around different formats,' Cantor analyst Mike Dennis said.

‘The read across is that Tesco’s investment in margin and recovery plan could easily wipe-out the majority of its main competitors trading margins forcing them to reduce their dividends and capex and also forcing the discounters back to a loss making position, as they were in 2009 (Aldi lost £12 million in trading profit in FY09 on £2 billion of sales).'                    

But Shore Capital was more circumspect in its response, repeating a hold rating.

‘It is very disappointing to see this update, which fundamentally raises questions in our minds about the capability of the management under Mr Clarke at this once great company,’ Shore analyst Clive Black and Darren Shirley said in a note on the stock.

‘As such, we expect, as part of a range of measures, considerable senior management change under Mr Lewis in time, as Tesco needs a world class top team to take it forward. ‘

The duo expect Tesco to ‘further reset’ its UK trading margins but are prepared to give its new boss the benefit of the doubt, for now.

‘[However] Upside will ultimately emerge from what Mr. Lewis can deliver. And so we return to where we have been in this note. We need to await Mr. Lewis' arrival and prognosis of how he perceives the prospects at the most fundamental level for Tesco; earnings and income stream,’ Black & Shirley said.  ‎

‘In this respect where does capital expenditure settle, any potential disposal strategy (e.g. should Tesco list its Asia business in Hong Kong) and restructuring charges are also at the front of mind.'

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Alastair Mundy
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