Right now I’m analysing some of the most popular companies in the FTSE 100 to establish if they are attractive long-term buy and forget investments.
Today I’m looking at Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US)
What is the sustainable competitive advantage?
In the retail sector, bigger is better and with a 30% market share and 3,000 stores here in the UK, Tesco is by far the biggest retailer in the country, and the third biggest retailer in the world.
Indeed, Tesco’s size and market dominance mean that the company can almost run itself. In particular, even though the company’s recent troubles in the UK and in the US are starting to raise concern among investors, Tesco is still extremely profitable, producing a free cash flow of £2.5bn during the first half of this year.
This free cash flow easily covered the company’s total £1.2bn dividend payout and gave the company room to retire £1.2bn of debt.
In addition, during 2012, the company achieved a return on assets of 8.3%, only slightly below that of industry behemoth Wal-Mart, which achieved a return on assets of 8.5% and significantly above the industry average of 5.2%.
Moreover, as the company is not producing the goods that it sells, management can regulate the company’s profit margin by pushing down suppliers prices – ensuring that the company remains profitable.
Company’s long-term outlook?
Tesco has been around for nearly 100 years, so the company knows how to manage itself through the good times and the bad.
Unfortunately, despite Tesco’s experience the company is not immune to competition. Indeed, the firm is currently having to fight a vicious price war with competitors, which has led to a contraction in the company’s gross profit margin from 6.7% to 5.5% over the past year.
In addition, Tesco is facing increasing competition from online competitors such as internet giant Amazon.
Still, Tesco’s size means that it can afford to spend where its peers cannot. In particular, the company recently spent £500m on upgrading its IT system to improve stock control funded entirely from retained profit.
Furthermore, many studies have shown that customers prefer shopping for food in store rather than online. So, as of yet, online competition is not a serious threat to the company.
Foolish summary
All in all, Tesco is a very defensive company, which can almost run itself. In addition, the company’s huge size, global diversification and financial firepower mean that it is able to keep ahead of its peers and invest for future growth, without having to rely on borrowing.
With nearly 100 years of history behind it and a very defensive business model, overall, I rate Tesco as a very good share to buy and forget.
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In the meantime, please stay tuned for my next FTSE 100 verdict
> Rupert owns shares in Tesco.