Tesco’s (TSCO) share price has been languishing since the company was embroiled in accounting scandal and made a £6.3bn loss. With a turnaround in progress and the company returning to profit, investors may think that this is an ideal opportunity to buy. It’s not.

The supermarket sector.

Tesco finds itself between a rock and a hard place. Whilst competitors with defined markets steam ahead Tesco is having a bit of an identity crisis.

Whilst Aldi and Lidl dominate on pricing and Waitrose and M&S (MKS) dominate on quality, Tesco is left wondering what it stands for.

You may think that Tesco has inserted itself right in the middle, focusing on price and quality but I’m afraid it’s a case of trying to please everyone, and in turn pleasing no-one.

Sainsbury’s have managed to insert themselves into Tesco’s traditional niche of ‘quality at a reasonable price’, leaving Tesco with no apparent core market.

 

The future – Where is Tesco positioning itself?

Moving forward, Tesco’s strategy is to focus on price and a superior customer shopping experience. The current plan appears to have had limited success.

UK like for like sales are positive again (albeit by a mere 0.3% last quarter), but this comes of negative growth in the previous 3/4 quarters.

Screen Shot 2016-08-20 at 21.25.36

*Tesco Q1 results – investor relations sector on their website.

The company is also “redirecting coupon spend” into ensuring lower shelf prices in a bid to compete with Aldi and Lidl. From what it looks like to me Tesco’s strategy  simply boils down to competing directly with Aldi and Lidl for price-focused consumers. Bad move!

By fighting Aldi and Lidl at their own game, Tesco is spending time and resource to offer what’s already on offer. 

Aldi and Lidl continue to grow their market share and Tesco can do nothing but wait until their customer base bottoms out.

Here’s the current state of affairs, drag the slider in order to compare dates.


Another major concern for Tesco is that Asda which is owned by US giant Walmart (WMT) is also weighing in on the price war. This will surely further pressure Tesco’s market positioning. The sheer scale of Walmart and its dominance of the U.S market would surely mean it would outlast Tesco in any war.

Consumer spending

As if things weren’t bad enough, consumer spending on groceries and non-alcoholic beverages in the UK remains under pressure. Despite glimpses of hope for the sector with increased spending on food in March this year (0.2% increase) – It appears that as the UK’s voted to leave the European Union has de-railed progress and caused families to tightening their belts. The most current Consumer price figures showed that spending on groceries is down 2.6% since the Brexit vote.

Source: http://www.tradingeconomics.com/united-kingdom/inflation-cpi

Financial position

Believe it or not, Tesco grew monstrously to become much more than a supermarket. It owned Garden centres, Coffee shops and even restaurants. Whilst this may be thought of as an advantage, these projects grew to become a burden on the company by distracting it from its main supermarket offering.

Thankfully, new CEO Dave Lewis offloaded these companies, using the proceeds to pay off debt (£6Bn from the sale of Korean assets) leaving Tesco’s balance sheet looking healthier.

He also eliminated the dividend, freeing up much-needed cash flow for the battle against Aldi and Lidl. But, the company’s debt remains stubbornly high with a £2.6bn pension deficit leading to a total debt of £15bn.

Increased competition in the supermarket has slashed Tesco’s margins from 6% in 2012 to only 2% today. As competition continues, so will the pressure on Tesco’s margins leading to lower profits for longer. It’s really hard for me to see any easing in Tesco’s financial position in the near term.

Value.

Just by looking at the share graph, many people assume, wrongly, that Tesco’s share price is appealing. Tesco’s share price has dropped from near 500p in 2007, to half that today, but that doesn’t make the share’s at all appealing.

Whilst there are some positive signs for Tesco such as;

  • A return to a positive FCF
  • An impressive £6.5bn cash pile

I’m afraid that Tesco’s share price offers little value to investors.

Reported EPS for 2016 come in at 3p giving us a p/e ratio of 53. This is much higher than FTSE 100 peer Sainsbury’s (SBRY) that trades at a p/e of 11.

Even if we take the highest analyst earnings estimates for Tesco in 2017 (earnings of 8.25p a share) the shares are still trading hands at a p/e of 18.7.

Summary – lower for longer

It appears that the market has already priced in any 2017, 2018 gains for Tesco. This is despite continued competition which makes achieving analyst estimates challenging.

Tesco has never traded for such a high earnings multiple (over 50) . It would therefore be reasonable to expect that they won’t in the future.

It seems that investors are pricing Tesco as if it was still the dominant force it was in 2012. We must remember that Tesco today is far smaller. It sold £6.5bn of Korean assets, Dunnhumby (owner of its clubcard division), coffee shops Harries and Poole and Giraffe restaurants. It also has a smaller share of the grocery market and lower margins on products (2% in 2016 vs 6% in 2012).

A return to fortune is already priced into the shares at current levels. Even at 159p a share Tesco’s share price remains too high.