It has been a painful several years for long-term Tesco (LSE:TSCO, Financial) investors. I humbly admit error in praising this company. The recent accounting scandal may have been hard to predict, but the advance of the hyper-competitive discount chains had been coming, and Tesco was ostensibly the most exposed of the large grocers.
But to look at the collapsing stock price and hear CNBC describe the stock as “risky” is absolute nonsense. I see the 16.2 billion pound valuation and the 15.5 billion pound book value and say to myself, ‘When can you buy a non-financial company with significant, albeit slowly shrinking market share at over 5% book value?’ The answer is almost never, and in fact, it offers much more safety than a company like Target which sells for a multiple of book value and is hardly a greater company than Tesco.
Tesco is reporting lower profits, but they are still profits and are they going to be added to book value. Are their assets less than they report? While possible, it’s unlikely especially as their UK real estate portfolio has grown with the market and the company is moving towards liquidation of these assets. But being the value investors we are on this website, unless it’s selling for less than the net current asset value, liquidation value is less important because Tesco surely won’t be liquidated. So then we need to ask what kind of earning power is Tesco capable of in years ahead.
Sales have been about 64 billion pounds in recent years and we’ll soon discover if in fact it should be lower. Tesco had been accustomed to 4% margins in years past, but we can safely bury those good old days and embrace the new normal for UK grocery. A very modest 2% profit margin with last year’s sales puts Tesco at a fair 12.5 price to earnings. The company’s sales may even grow should they cut prices. This basic phenomenon was embodied in the firm’s early motto: “pile it high, sell it cheap” i.e. by selling it, cheap people will presumably buy lots of it.
I remember listening to conference calls and hearing the previous CEO say he understood how important the dividend was to shareholders and that it would be maintained. The new CEO, Dave Lewis, came in and he promptly slashed the dividend by 75%. As a shareholder I should be bothered by that, but I’m not because it’s a signal of who he works for – customers, not shareholders. The company could have been milked for all its worth and embrace its maturity as Morrison’s seems to be doing or growth can be rekindled by investing wholeheartedly into the business.
I’m reminded of Bank of America circa 2011 when it appeared nothing could go right for the company and investors had seemingly given up. Was Bank of America going bankrupt? Would they ever make money again? The stock had collapsed to $5 a share. That must make it risky right? At $5 a share, those brave investors in Bank of America made good money. I don’t know that Tesco has hit its nadir yet. But at today’s prices it is hard to argue that you will lose a lot of money in the long-run.
