The shares of Tesco (LSE: TSCO) currently change hands above 200p, a level they last traded at in late September 2014. The obvious question now is whether the retailer’s revival plan, which was announced last week, could push the shares up to, say, 300p in 2015.
I wouldn’t rule out that outcome. Here are a few things you should consider before assessing the value of the UK’ s largest grocer.
Six Months Later…
I went through the announcements that Tesco made in the last two quarters of 2014 after the shares dropped below 300p in June. On the face of it, six months ago Tesco was more troubled than today. It’s easy to forget that back then Tesco was still led by Philip Clarke, its shares still offered a decent dividend yield, and there were no signs of a looming accounting scandal.
As problems mounted, Mr Clarke was fired and Mr Lewis joined Tesco on 1 September, one month ahead of schedule. During the new CEO’s tenure, the stock has lost 6% of value — but Mr Lewis should not take the blame for Tesco’s poor performance during the last quarter. After all, the shares of Tesco took a dive on 22 September when the retailer announced it had overstated its profits by about £260m.
Tesco’s performance is north of 10% once the capital losses registered on that day are not considered, though, and the shares have greatly outperformed the FTSE 100 index, on that basis. I am not concerned about possible fines related to the accounting scandal; Tesco can cope with them.
Valuation
Based on the fair value of its assets, Tesco could be worth at least 233p a share, according to my calculations, but it’ll certainly need to improve its profitability for the shares to rally to 300p. Here’s where the current restructuring plan could make the difference.
Cost savings are on the cards, but I reiterate the view that if Mr Lewis is serious about getting the business back on track. Large disposals would be needed to satisfy opportunistic investors and value hunters, both of which must invest in the business for the shares to surge by 50% or more in the next 12 months.
I believe Tesco has plenty of time to get things right in the light of a reassuring debt maturity profile, although Mr Lewis recently stated the group must cut its debt pile. As far as managing expectations goes, Mr Lewis is doing pretty well.
Profitability is shrinking, but Tesco’s diversified base of lenders and a ‘low rate’ environment should provide a helping hand, and although investors wonder whether Tesco may need a rights issue to recapitalise its balance sheet, I believe a cash call will be unnecessary in the next 12 to 18 months.
Moody’s & Mr Davies
Credit rating agency Moody’s has downgraded Tesco’s senior unsecured long-term rating to Ba1 from Baa3 — a “junk” rating. But a possible downgrade was already priced into the shares, in my view.
For investors seeking long-term value, one key piece of news last week turned out to be the appointment of Matt Davies, the chief executive of Halfords, who will run the UK and Ireland businesses from 1 June. Under his stewardship, Halfords recorded a terrific performance in the last couple of years, and I am confident he’ll do well at Tesco.
Tesco has cut heavy investment such as capital expenditures, so it will likely continue to close stores and cancel existing projects. Equally important, it has announced the “the initiation of consultation to close the company defined benefit pension scheme”. All these elements are likely to be followed by significant disposals, particularly overseas, which will contribute to push the stock up to at least 250p by the end of June, in my view. Then, a price target of 300p a share would become more realistic…