I used to think of Tesco (LSE: TSCO) as a defensive, cash-generating business paying generous shareholder dividends. Until around 2013, I thought Tesco shares were a solid component of my diversified portfolio.
Tesco shares crashed
But then the wheels came off the investment proposition. For the first time in about 20 years, annual profits declined. And the company owned up to taking its eye off the ball in its home UK market because of all the distraction of its overseas operations.
By 2004, Tesco had more sales floor space abroad than it had in the UK. But back then, more than 75% of the firm’s revenue still came from the UK. Something was wrong and things had to change.
Sometimes newer operations in a business can take time to build up to profitability. But Tesco has been scaling back its overseas operations for some time. The recent sale of the business in Poland is the latest in a long line of big divestments. And the unwinding of Tesco’s international expansion ambition has been fascinating to watch.
The company came out of France in 2010, Japan in 2012, the USA in 2013, South Korea in 2015, Turkey in 2016 and Thailand and Malaysia in 2021. The idea has been to focus on operations that are proving to be the most resilient and profitable, such as in the UK, Ireland, Slovakia, Hungary and the Czech Republic. Although it’s possible we’ll see further divestments ahead.
I’m not criticising Tesco’s international retreat. I’m a big fan of businesses deploying a sharp focus and concentrating on a narrow area of operations. And it’s common for companies of all types to expand with a two-step-forward-and-one-back approach. Indeed, businesses often open new branches only to close them a short time later because they don’t prove to be profitable. And that’s sensible business management in action.
Boxing clever
And, lately, Tesco has been boxing clever with its overseas programme. One insight the directors appeared to glean from the company’s experience is that overseas markets each need their own unique approach. Traditions and customer expectations differ between regions. And now Tesco tends to partner more with local operators and employs more local staff and management teams.
I think the Tesco business is in better shape and more in control of its strategy now than it has been for years. But would I buy the stock today? No, not yet. Because I’m still aware that the business is a low-margin, high-volume set-up. And that comes with risks. For example, it wouldn’t take much to upset the delicate balance between profits and losses and the sector is very competitive.
To compensate, I’d want a generous dividend yielding more than 5%. That would give me a short-term, repeatable return to start mitigating the risk of holding the stock. However, with the share price near 233p, the forward-looking yield for the current trading year to February 2022 is around 4.6%.
The valuation has been moving in the right direction, but it’s not low enough to tempt me into the shares yet.