Famed hedge fund manager Crispin Odey disclosed yesterday that at least one of his funds had bought shares in supermarkets giant Tesco (LSE: TSCO). Since opening in 1992, Odey’s firm has returned an average annualised return of 12.5%, so his deciding to build a position in Tesco certainly merits giving the shares a second look. Has he correctly called the bottom or do Tesco shares have further to fall?
Last week’s news that like-for-like sales in the UK were up 1.3% for the six-week Christmas period felt like the first positive news to come out of Tesco in years. Shares popped on the trading update and have avoided the broader market sell-off to gain 13% since the start of the year.
Despite this good news, I don’t believe a single data point will serve as the catalyst to reverse declines in Tesco’s share price. Nothing has changed the long-term outlook for the Big Four Grocers. Shopping habits have been shifting from a large weekly shop to small top-ups and online purchases, low-price chains have proved that low prices don’t necessarily mean low quality, and margins have been mercilessly slashed over competition for market share.
While any positive sales growth is good news for Tesco, it still lost market share over the Christmas period as German low-price rivals Aldi and Lidl continued to grow sales by double-digit figures. And this fight for market share looks set to continue for the foreseeable future with Asda parent Walmart’s decision to pump an additional £500m into discounting over the short-term. This means that Tesco’s margins, which have fallen from their traditional 5-6% range from just five years ago to 0.77% for the latest half year, are unlikely to improve any time soon.
Good news… and bad
One of the few bright spots for the large grocers has been the growth of online sales, estimated to be in the 6-7% range per year going forward. However, even Tesco’s high online market share won’t prove to be a panacea for the company as competition from the likes of Ocado, as well as traditional rivals, means estimated margins on internet sales hover around 1%. The recent entry of profit-ambivalent American e-commerce juggernaut Amazon into the online grocery delivery segment will further increase margin pressure on all competitors.
Growth in sales for general merchandise and clothing continued in the past quarter as Tesco, as well as rivals such as J Sainsbury, increasingly devoted empty space in large out-of-town locations to these items. While the additional foot traffic and sales these goods provide is welcome, they will remain minor players in overall revenue and won’t change the continually worsening market conditions in the core business of food sales.
Although Odey and other value investors may see the increase in Christmas sales as the turning point for Tesco’s share price, I firmly believe long-term investors will find the shares more of a value trap than a value play. There’s no catalyst for poor market conditions in the grocery business to reverse any time soon and investors can find much better uses for their capital than Tesco shares.