The British grocer-retailer, Tesco (TSCDY) seems to fit many of the features Buffett looks for in a stock. The stock is trading at an attractive price to earnings of just under 11. The company has grown profits and revenues throughout the recession. Sales have grown 31% from the period 2008 to 2011, but profits had grown even faster at 35%. These figures were more impressive than Walmart’s (WMT) which had grown 11% and 29% respectively. The company averaged a return on equity over 15% for the past 10 years and has held a profit margin of around 4% during the period and 4.4% this past year. Contrast these margins with US grocery stores such as Kroger, Safeway and Supervalu which have averaged profit margins closer to 1% over the same period. These chains are not the juggernauts they used to be as Walmart has elbowed its way into the US grocery market taking some 30% market share in the process.

It is not surprising then that Buffett expressed his concern when Tesco decided to enter the competitive US market with the Fresh and Easy brand stores. Though these are a much more organic-themed grocer, the chain would still be competing with giants such as Costco (COST) and Walmart. The Fresh and Easy store is a unique concept in that it is exclusively self-checkout, but the chain has yet to see the kind of turnover it needs to become a profitable entity for Tesco.

But beyond its small foray into the US Tesco sits in an enviable position on top of the British grocery market. Tesco holds the greatest market share at 30% followed by Wal-Mart-owned Asda with 16.9% and then Sainsbury’s (16.3%) and Morrisons (12.3%). Collectively these grocers account for 76% of the Tesco grocery market. This kind of market power lends itself to excellent economics (for shareholders) and sometimes as was the case recently, incidents of impropriety.

In 2007 the leading British grocers were accused by the Office of Fair Trading of conspiring to control dairy prices. Asda, Sainsbury and Safeway all confessed to the crimes, but Tesco (the largest) denies any agreement to fix prices. Whether or not the allegations ring true the company certainly would’ve been a beneficiary one way or another to the other grocers’ actions. If the grocers raised prices Tesco would’ve captured a higher asset turnover with its lower prices. If Tesco followed suit they too will have yielded higher profit margins.

In either case the British grocery oligopoly remains and Tesco’s healthy profit margins will likely continue into the future. With food prices being elevated as they are now and farming such a profitable trade we could even expect higher profit margins in the future if farmers start churning out bumper crops and consequently driving food prices down for the grocers. These favorable long-term economics are probably just some of the reasons why Buffett counts Tesco as one of his few international stocks.

The Strategy of Ben Graham – Warren Buffett’s Mentor

From 1923 to 1957 Warren Buffett’s mentor, Ben Graham, followed a strategy of investing in net-nets. He said: “It always seemed, and still seems ridiculously simple to say that if one can acquire a diversified group of common stocks at a price less than the...net current assets alone…the results should be quite satisfactory. They were so in our experience, for more than 30 years.”
Today net-nets are rare. They are collected under GuruFocus’ Net-Net Screener. GuruFocus also publishes a monthly newsletter which recommends the safest net-nets. All of these are included in GuruFocus Premium Membership.

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