It’s fair to say that the preliminary results from Tesco (LSE: TSCO) were not a pretty sight when released to the market on Wednesday. The shares opened ‘up’, but as the full extent to the losses seemed to sink in, they finished the day in negative territory.
Sometimes the market reaction to bad news can present opportunities to patient investors, willing to look past the news just gone: after all, the market looks forward, prompting me to take another look and see whether I should change my negative stance on the company. Here are my thoughts…
The Good…
On balance, it wasn’t all bad news. Despite the headlines, claiming that the likes of Aldi and Lidl were eating into Tesco’s profits, like-for-like sales in the UK actually rose for the first time in four years. It was also noted that the transformation plan outlined in January was progressing well, and it was pleasing to see that there was a commitment to enhanced disclosure when reporting property valuations and the infamous commercial income, which lead to such a furore last year.
The write-downs were heavier than many expected: I think CEO Dave Lewis threw everything including the kitchen sink, and this can be seen as a plus, as it gets all of the bad news out and gives the company a fresh start as it moves forward under new leadership.
The Bad…
Now for the bad news – sadly there was no shortage…
Being an international company, Tesco will have advantages over other UK-listed supermarkets like Sainsbury’s and Morrisons, when times are good. Unfortunately, when things are tough, it is difficult to know which way to turn as the battles are being fought on several fronts.
Indeed, the company reported that trading was tough, especially in Korea – it is possible that this was a known issue, as Standard Chartered has reported difficult conditions here for some time previously. However, just to compound issues, there was also a disappointing performance from Europe – again, there are not too many surprises here, either. However, it does mean that several areas of the business are finding trading tough – not ideal when the UK division needs urgent attention.
One of the most concerning items, for me at least, was the £270 million annual repayment towards the pension deficit. This is a cash cost, and a significant one at that. In addition, consultation has begun with employees re: a defined benefit scheme with a much less generously defined contribution scheme. This, whilst necessary given the challenges facing the company, will do nothing for moral in the short term.
And The Ugly Truth
Personally, I think that “Drastic” Dave Lewis is living up to his reputation and, given time, could well turn this tanker around to become a leaner, fitter beast, ready to take on its competition and better equipped to protect its market share. A quick look at the chart, however, paints a rather painful picture for long-suffering shareholders:
With the shares trading at nearly 22 times forward earnings and expected to yield less than 1% in the year to 2016, I think that they are significantly overvalued. For me to be interested in investing here, I would be looking for a price closer to 150p per share and signs that the business was starting to fix its problems and grow again. I suspect that I would also look for a good margin of safety of 20% or so, just in case the story changed for the worse. With the shares trading at 225p currently, they are too rich for my blood.