Many investors, myself included, have been heavily bearish on the long-term chances of Tesco (LSE: TSCO) digging itself out of the hole no-frills competitors and its own folly have created. However, with two positive quarterly results booked in a row, has the calculus changed for the grocery giant?
I don’t believe so. While like-for-like sales growth was positive over the past six months, there’s still a long journey ahead for the struggling company. The biggest issue confronting Tesco is miserably low margins. The company didn’t break out margins in its Q1 results, but the prior quarter saw positive growth in UK operating profit margins to 1.17% from 1.1%. Positive growth is of course welcome, but even this improved number is before exceptional items and remains far, far below the regular 5% to 6% trading margins the company posted as recently as 2012.
The question then becomes whether or not margins can return to their previous highs or anywhere close. I remain doubtful. The main reason is that the wider market challenges that battered every major grocer in the past decade are still in force. Low-price rivals such as Aldi and Lidl have been joined by online-only outfits Ocado and Amazon, portending further price cuts by competitors seeking to shore up market share.
Tesco has the added wrinkle of having to deal with a mountain of net debt that measured £5.1bn at year-end. The company has whittled this down considerably by selling-off major overseas operations, but it’s running out of big ticket items to pawn! Bringing overall debt down in the future will entail further contributions from operating cash flow, constraining dividend growth over the medium term. With dividends expected to be minimal once they return, a pricey forward valuation of 23 times next year’s earnings and a negative market outlook, I feel confident that steering clear of Tesco is still the right move.
Sharper focus
Shares of diversified miner Anglo American (LSE: AAL) have nearly tripled from their January lows. However, Foolish investors know that success is best measured in years and decades, not quarters. So, over the long term, are Anglo American’s prospects better than they were just a few months ago?
Possibly. Management has wisely decided that the path it followed during the Chinese-driven commodity super-cycle of diversifying into mining everything from coal to nickel was foolhardy. The plan is now to divest the majority of assets that aren’t focused on copper, diamonds and platinum. These three are the South African miner’s breadbasket goods that are cheap to produce and have relatively bright outlooks for global demand in the coming years.
Asset sales and the end of dividend payments will also assist efforts to cut sky-high net debt of $12.9bn, which represented a worryingly high gearing ratio of 37.7% at year-end. Net debt this high puts Anglo American in a worse position than many of its competitors, so there are healthier options for investors interested in exposure to the industry at a low point. That said, Anglo’s array of low-cost-of-production assets and focus on commodities that are less reliant on Chinese infrastructure spending make it an interesting company to watch in the coming quarters as divestments are announced and production levels reported.