With the firm’s recently reported accounting scandal, Tesco’s (LSE: TSCO) problems get deeper and deeper.
Not only have profits been slipping for years, all bets are now off when it comes to future profit forecasts as, along with the accounts, profit guidance hitherto could be no more than a work of fiction.
What’s happening to the industry?
The business model upon which the entire mid-tier supermarket industry is built in the UK seems holed under the water.
Since last decade’s credit-crunch, consumers have faced an income squeeze of pip-squeaking proportions. Domestic bills have pretty much doubled and household earnings for the masses have, at best, remained stubbornly static. At worst, and in many cases, they have fallen.
That’s why, in the words of rival supermarket chain Morrisons‘ chairman, the trading landscape has changed because a customer shift to value seeking seems structural this time rather than cyclical. Witness the rise and rise of discounting competition, such as Lidl, Aldi and others, and apparently permanently squeezed prices on mid-tier supermarket shelves — the message is that previous profitability from the old way of doing business for the likes of Tesco is not coming back.
When will the profit-slide halt? Well, there’s no arithmetical limit beyond that of the firm’s turnover. Profits can go to zero, then beyond zero into loss — perhaps losses as big as Tesco once posted profits, counted in the billions.
Let’s hope that doesn’t happen, but as the largest UK operator Tesco has a lot of competition snapping at its heels trying to take market share. If Tesco begins to lose critical mass in its local markets, once proud assets could turn into big liabilities and new boss, Dave Lewis, could end up managing the wholesale contraction of the Tesco asset base.
So, what’s Tesco worth?
We always used to value Tesco according to its earnings, whether historical or what we thought the company would earn in the years ahead. I’d argue that it’s unwise to rely on anyone’s estimate of earnings now.
Tesco seems more like a Ben Graham-style value proposition as it stands. The only ‘safe’ way to look at it is with reference to its net asset value. With the last set of full-year accounts, the firm reckoned its net asset value stood at around 135p per share. Without wishing to seem alarmist, it doesn’t take a big stretch of the imagination to see Tesco shares trading around that level from here — today’s 195p seems but a spit away.
Dave Lewis and his team have a mighty task ahead to turn Tesco around in the face of changing and deteriorating market conditions. It could go either way, and a low-margin, high-volume business model is perhaps the worst kind of candidate for a turnaround investment.
What now?
Tesco looks risky to me and I’m glad I’m not involved with the shares.
Perhaps you disagree and see attraction in Tesco now? Ultimately, we all need to make our own investing decisions, but an informed decision often pays best, which implies doing our own research.