Tesco (LSE: TSCO) and BP (LSE: BP) are both highly respected companies. Tesco still dominates, by some distance, the supermarket business in this country. BP is one of the world’s leading oil companies; it coped with the Deepwater Horizon disaster with admirable integrity and fairness, in the face of a torrent of litigation. It is difficult to think of any other companies in the FTSE 100 that are better run.
And yet, despite all these strengths, I’m afraid to say both these companies are suffering at the moment.
It’s all about supply and demand
One of the most common mistakes people make is linear thinking: that is, thinking that a current trend will continue indefinitely. Supermarkets have been successfully expanding over many years, and have been growing profits and share prices. After this happens year after year, and decade after decade, people eventually assume this is a one-way bet. But, just as there is a beginning to everything, there is also an end.
I have written many articles about Tesco. With hindsight perhaps I overanalysed, and only now have I really got the reason behind Tesco’s decline. It is perhaps the most fundamental, but often overlooked, rule of economics: supply and demand.
A decade ago, supermarket retail was dominated by Tesco, Sainsbury and Asda, with Morrisons just emerging. Today the main competitors are Tesco, Sainsbury, Asda, Morrisons, Aldi, Lidl, Waitrose and Marks & Spencer.
Until recently, every one of these competitors was expanding, building more stores across the country.
Now look at BP. This company, along with other oil majors such as Shell, Exxon and Total, has been investing billions of pounds to extract oil from the furthest reaches of the world. Meanwhile, the shale oil revolution means that oil production in the US is rapidly ramping up. All the while, the national oil companies of countries such as Saudi Arabia and Venezuela are determined to maintain their market share.
Nobody predicted this
But the number of shoppers in this country has not increased much, and they are not spending any more money than they used to. And, with economic slowdowns in both emerging markets and Europe, and growth in renewables, oil consumption is also hardly increasing.
So, with both the supermarkets and the oil companies, we have rapidly increasing supply but static demand. The result is fierce competition, falling prices, and tumbling profitability and share prices. The amazing thing is how hardly anyone seems to have predicted the dramatic structural change which is now taking place.
The estimated P/E ratio of Tesco is 11.8, rising to 14.2, with a dividend yield of 2.2% rising to 2.5%. The P/E ratio of BP is estimated to be 10.4, falling to 10.2, with a dividend yield of 5.5% rising to 5.7%. These numbers seem reasonable, but IÂ fear they may be over-optimistic. That’s why I am reluctant to invest in either company.