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Tesco Falls Below Buffett’s Price; Will He Buy More?

January 13, 2012 | About:
Holly LaFon

Holly LaFon

255 followers
Warren Buffett first bought shares of Tesco (TSCDY), a UK-based retailer giant, in 2006. In the following years, the stock rallied. But recently, the company’s stock fell 14% after reporting a disappointing forecast. Buffett said in a November interview with NBC that “If the price came down on Tesco, I’d buy some more of that.” But things have changed at the company to call into question whether Buffett will still find Tesco a buy-and-hold-forever stock. Buffett bought more shares of Tesco the last time the stock dropped. His first purchase was in 2006, with 229,707,000 ordinary shares, or 2.9% of the company, at about $17.50 per ADR. Three UK ordinary shares equal one ADR in the US. By 2007, the price had risen to over $30 per ADR, but soon began falling as the 2008 financial crisis intensified. In 2009, Berkshire reported that it had acquired 6,940,373 more shares at the same price, the equivalent of $17.50 per ADR. In 2010, he bought again on a price dip, purchasing 7,916,400, again at about the equivalent of $17.50 per ADR.

On November 29, the date Buffett made the comment that he was waiting for a price pullback to acquire more Tesco shares, the price was at $18.59 per ADR, over a dollar more than his other purchase prices. The stock closed at $14.50 per ADR on Friday. Investors can now buy the stock about 20% cheaper than Buffett paid.

Tesco once had everything Buffett looks for in a company, but things have changed there to induce the latest price drop. Tesco had a strong market share of 30.5%, but that fell to 30.1% in the 12 weeks leading to Christmas Day. Revenue increased almost every year of the last decade except for from 2009 to 2010, and it remained highly profitable straight through the recession. From the period of 2008 to 2011, Tesco’s sales increased 31%, and profits grew at 35%. GuruFocus author Josh Zachariah notes that these figures outpaced Walmart, which grew sales at 11% and profit at 29%.

“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 (KR), Safeway (SWY) and Supervalu (SVU) which have averaged profit margins closer to 1% over the same period,” Zachariah noted.

Tesco is also the fourth-largest retailers in the world, behind Walmart (WMT), Carrefour S.A., and Metro AG., and had higher sales growth in 2009 in the top 10 at 4.8%. About two-third of its profits come from the UK, and the other third come from Asia and Central Europe, though its international operations have dragged. The company had to discontinue its 12 stores in Japan due to losses. Buffett has mentioned that emerging market exposure has never been and is still not part of his criteria.

Buffett also bought more shares of Tesco several months it installed its new CEO, Philip Clarke, who took over for Sir Terry Leahy in March, something of a tacit approval of his strategy.

The company has disappointed Buffett on at least one point, its U.S. operations, which have also struggled. For the year ending Feb. 26, 2011, its U.S. operations lost £186 million, an improvement from the prior year, though sales increased 41.8%. Buffett told shareholders at his annual meeting on Omaha that Tesco’s attempts to enter the world’s largest grocery market were “foolhardy.”

But Tesco has hit a rough patch even in the UK. "In a challenging economic environment, we made good progress internationally but despite record sales, we are disappointed with our seasonal trading performance in the UK,” said Philip Clarke, chief executive, in a profit warning issued January 12.

The primary reason for the slip was its “Big Price Drop” plan, in which it cut prices to lure in Christmas shoppers. While customers bought 5.2% more in the six weeks to January 7, volume did not increase enough to offset the lower prices. Combined with a “challenging consumer environment at home” and “early signs of cautious behavior elsewhere,” the company expects that “underlying profit before tax and earnings per share for 2011/12 will be broadly in line with market consensus forecasts” and “Group trading profit growth to be around the low end of the current consensus range.”

Tesco was actually one of many retailers to report sales declines over the holiday season, though sales were up slightly overall. The British Retail Consortium and KPMB reported that UK retail sales were 2.2% higher on a like-for-like basis from December 2010, when snow caused sales to fall 0.3%. The organization concluded that discounting drew out more customers, but were made at the expense of margins, resulting in weaker earnings.

"December's figures saw retailers achieve a 2.2 per cent increase in like-for-like sales, albeit against a background of heavy discounting and long opening hours. The month's figures saw the strongest growth in food sales of the year as people spent on food for the big day,” Helen Dickinson, head of retail, KPMG, said.

Though Buffett has previously responded to Tesco drops in share prices as an opportunity to buy more shares, as long as the underlying fundamentals of the company remain the same. However, Buffett rarely pays attention to short-term swings, and the size, financials and solid management at the company may mean more to him than its recent disappointment. Today, Tesco ADR is trading at a 20% lower price than when Buffett purchased.

It’s good enough for Buffett; now at 20% discount, is it good enough for you?


Rating: 3.8/5 (24 votes)

Comments

hardcorevalue
Hardcorevalue - 2 years ago
I don't know much about tesco but the comments on the bronte capital blog are pretty negative. It looks like they are the mid price player (which differs from walmart) and are getting squeezed on both sides. i'm still researching it though.

http://www.blogger.com/comment.g?blogID=4815867514277794362&postID=4770437184293542422
Josh Zachariah
Josh Zachariah - 2 years ago
Great article!
pravchaw
Pravchaw premium member - 2 years ago
Good article. Could you follow this up with a valuation model?
vgm
Vgm - 2 years ago
Very useful. Thanks.

Buffett likes to say "If I can't see what a company will be doing in ten years' time, I don't want to buy it."

That philosophy, on top of his very recent comments in November saying he would buy more if the stock dropped, make it extremely unlikely that he has changed his mind on Tesco. I expect him to buy.

For European readers, his last purchase in Sept 2011 was 34 million shares at a cost of 120 million pounds - 353p per share. It closed Friday at 317p, 10% below that purchase price.

(We should be careful with the ADR argument, since the dollar-pound exchange rate varies. I don't think Buffett buys the ADR.)
DfiinancialH
DfiinancialH - 2 years ago
Hold forever is hold forever I'm pretty sure he bought a lot more of that and that he was happy like a kid after the slump
graemew
Graemew - 2 years ago
While Tesco has run into a pothole due to tactical errors, the future long term looks very strong, more so in the rapidly expanding Asian markets where the potential for growth is huge. I would buy more if I hadn't already exceeded my portfolio percentage limit,

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