It's time for a rethink about the supermarket chain.
Well, can you believe it? After last week's Christmas trading statement, the share price of Britain's largest retailer Tesco (LSE: TSCO) has tanked, falling by some 20%.
The sure thing that wasn't
You can be certain of few things in life but, until last Thursday's statement, just about everyone -- including myself -- was confident that Tesco would continue to do well.
Indeed, just a few days before, I was thinking of buying some shares in the firm. Now I'm breathing a sigh of relief that I didn't go through with the purchase.
The investment thesis was that Tesco would staunchly defend its UK sales while continuing to grow abroad. We knew that the firm was unlikely to grow fast in its home market, but the market share would at least be maintained.
How wrong we were. Like-for-like sales in the UK for the six weeks to 7 January were down 2.3% on the previous year. Don't forget, a year ago sales had taken a knock because of the terrible weather, so these were pretty poor results.
In contrast, like-for-like sales in the competitor supermarkets Wm Morrison (LSE: MRW) and J Sainsbury (LSE: SBRY) rose.
The Big Price Flop
What went wrong? Well, the competition between the supermarkets has been as fierce as it has ever been.
Asda has been putting across the consistent message that it is the cheapest retailer out there. Sainsbury, traditionally the most expensive of the supermarkets, has used its Price Match campaign to match Tesco's discounts. And Morrison's also been spending heavily on advertising, with the emphasis on its strength in freshly prepared food.
In contrast, Tesco's Big Price Drop campaign has turned out to be a Big Price Flop. The reductions were in own-brand products, whereas the big draw for consumers is offers on branded products. It seems customers have pocketed the savings and not spent any more.
Tesco bulls would argue that overseas sales and profits continued to grow. But we now have a situation where the company's growth abroad is negated by contraction in the UK. And remember, three-quarters of the business' profits are still made in Britain.
What to do now
So what should the investor do now? Well, several will have jumped in on the day of the statement to scoop up more Tesco shares. But I wasn't tempted and, sure enough, the company's shares have continued to fall in the following days.
The thing is, the trading statement was also effectively a profits warning from chief executive Philip Clarke, who predicted that there would be minimal profit growth for 2012/13. That's why I don't think there will be a rapid rebound in the share price.
Instead, I feel the market will take a 'wait and see' approach to Tesco, and I think you should do the same. The question is: is this a mere blip in the ongoing expansion of the business, or is this the end of an era?
I remember the 80s and early 90s when Sainsbury, and not Tesco, was the king of the supermarkets. In 1993, Sainsbury's share price peaked at 577p. 19 years later, it stands at only 283p.
My personal view
Could Tesco go through the same long-term decline? Well, I personally think it is highly unlikely, but the honest answer is we don't know. Certainly, Philip Clarke -- in his first year as chief executive -- has a lot to prove.
The market will await the full-year results in the spring with interest. In the meantime, the share price may drift with little sense of direction. I am keeping the firm on my watchlist, and might still be interested if the share price fell further.
My personal view is that Tesco has grown too large in the UK, and it now faces a gradual erosion of its market share. But it will continue to expand overseas, and overseas growth is going to become more and more important for the business.
At 312p a share, the company is on a price-to-earnings ratio of less than 10, and a predicted dividend yield of 5%. Even if the prospects for growth are diminishing, Tesco could become a decent value and income play.
When talking to people about Tesco, I hear too many stories of overcrowded supermarkets, poor customer service and long queues. If the chief executive wants to reinvigorate the business, he has to start with the basics: good service, great deals, an excellent standard of produce and a shopping experience that the customer really enjoys.
Just as Tesco transformed itself in the early 90s, it must do so again. Philip Clarke has a difficult task on his hands. Let's hope he rises to the challenge.
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> The Motley Fool owns shares in Tesco.