How Long Will It Take Tesco To Recover?

Published in Investing on 16 October 2012

Past supermarket profit warnings suggest it could be a long hard slog.

Top UK supermarket Tesco (LSE: TSCO) shocked the market back in January with its first profit warning in 20 years. The FTSE 100 (UKX) firm saw almost £5 billion wiped off the value of its shares at a stroke.

Nine months on, and a disappointing set of interim results later -- a double-digit percentage fall in trading profit -- Tesco's shares languish at the same level they dived to immediately following the profit warning.

So, how long will it take Tesco to recover? Let's have a look at three other supermarkets that have issued profit warnings in the past 10 years.

Morrison's meal deal: four years of indigestion

In March 2004, Wm Morrison Supermarkets (LSE: MRW) completed the £3.4 billion acquisition of rival chain Safeway. Within six months it issued a profit warning for its fiscal year 2005 -- the chain's first profit warning in 37 years.

By June 2005, Morrison had issued no less than five profit warnings, extending the fallout from the acquisition into fiscal year 2006. As the table below shows, it would take until 2008 for Morrison's earnings per share (EPS) to surpass its pre-profit-warning level of 2004

 20042005200620072008
Revenue ( £bn)4.912.112.112.513.0
EPS (p)12.68.1-9.59.320.8
Dividend per share (p)3.33.73.74.04.8

Of course, Morrison's bout of severe indigestion from feasting on Safeway is very different to Tesco's current situation.

However, there are perhaps a couple of points worth noting. On the optimistic side, Morrison was able to maintain its dividend despite its difficulties. On the pessimistic side, analysts remained over-optimistic about Morrison's earnings, not only after the first profit warning but also through the following twelve months.

Sainsbury's six years of hurt

J Sainsbury (LSE: SBRY) issued three profit warnings for its fiscal year 2005. The company had been chasing higher margins at the expense of the customer experience. Sound familiar?

Sainsbury's directorspeak and actions to remedy the situation in 2004/5 also reverberate in many ways with Tesco's in 2012. Here are some pertinent snippets from Sainsbury:

'There is nothing fundamentally wrong with the brand. The problem was that we hadn't delivered it well enough in recent years.'

'Our number one priority … to make things better for our customers as quickly as possible … to "fix the basics".'

'Recruitment of 3,000 additional colleagues into stores.'

'131 stores have not received any investment for a number of years … Customers, representing 20 percent of Sainsbury's sales, are not experiencing the best store environment and these stores will be refurbished over the next two years.'

'Overall, we think we've made a good start, but there's still much left to be done.'

As the table below shows, there was indeed much left to be done.

 2004200520062007200820092010
Revenue ( £bn)18.216.616.117.217.818.920.0
EPS (p)20.7-3.03.819.219.116.632.1
Dividend per share (p)15.77.88.09.812.013.214.2

Sainsbury had reckoned it would take until fiscal year 2008 to bring about lasting change. As far as earnings performance was concerned, it took until 2010 for EPS to surpass its pre-profit-warning level of 2004. Meanwhile, the dividend, which was slashed in 2005, had yet to regain its former level.

Carrefour on all fours: five years and counting

French supermarket giant Carrefour has similar revenues to Tesco and, like its UK counterpart, is the dominant force in its home territory.

Carrefour issued a profit warning in June 2008 and a second six months later, citing weaker consumer spending, particularly in Europe. An uptick in revenues and earnings in 2010 proved to be a false dawn and the company issued five profit warnings for its fiscal year 2011.

As the table below shows, an improvement is expected in the current year. Nevertheless, the dividend has been cut, and both EPS and dividend per share are forecast to be at around half their pre-profit-warning level of 2007.

 200720082009201020112012 (forecast)
Revenue ( €bn)82.187.087.491.580.580.8
EPS (c)267186486456134
Dividend per share (c)10810810810810859

Foolish bottom line

It took four years for Morrison to get its EPS back to the level before the first profit warning; it took Sainsbury six years; and for Carrefour it's five years and counting.

Tesco may pull a quick-turnaround rabbit out of the hat, but if recent supermarket history is any guide, it could be a longer and rougher ride than I suspect many investors are expecting.

Certainly, Tesco's problems amount to a whole lot more than one period of poor Christmas trading. In the words of the chief executive, the company needs to address "long-standing business issues" in the UK.

Once on the wrong tack, supermarkets, like supertankers, typically take an age to change course. Tesco's shares may be trading at under 10 times current-year earnings forecasts and offer a prospective yield of 4.8%, but investors need to consider the opportunity cost of a protracted recovery.

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> G A Chester does not own any shares mentioned in this article. The Motley Fool owns shares in Tesco.

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Comments

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mcturra2000 16 Oct 2012 , 1:01pm

Very nice article.

KeyLifeSkills 16 Oct 2012 , 2:19pm

Well done - interesting article.
Personally, I've done very well out of Tesco simply by trading its price range. So from my point of view, its volatility has been an absolute gift.

Regards,
kls

goodlifer 16 Oct 2012 , 5:57pm

Please let us know a bit more about Neil Woodford, the guy you keep trying to sell.
What's he actually achieved?

jaizan 16 Oct 2012 , 11:28pm

A good article.
Also, well done for bringing in the Carrefour story.
The figures show an EPS fall ov over 80% in 2 years and 5 years on down the line, earnings have still only recovered to about half the 2007 level.
There is no certainty about supermarket earnings.

As for Tesco, they need to get VERY cheap or I need to see clear improvements at the local store before buying the stock.

theredflag 17 Oct 2012 , 8:54am

Very good article.

ScillyFool 17 Oct 2012 , 11:33am

Looks like it could be sooner than you think!
UBS upgrades Tesco from hold to buy.
Possibility of Tesco exiting US and returning £8bn to shareholders over the next 6 years.

http://www.guardian.co.uk/business/marketforceslive/2012/oct/17/tesco-buyback-exit-us-ubs

SevenPillars 17 Oct 2012 , 1:45pm

ScillyFool. That is an analyst suggestion, no indication that Tesco will do that. City talk, nothing from Tesco. They've probably got a few long positions on after the recent fall.

If Tesco got out of the US the share price could easily go up 15-20% on the back of it though.

ANuvver 17 Oct 2012 , 7:12pm

A famous investor - click here to find out who - has been agitating for Tesco to dump Fresh & Easy. If it were to happen and SevenPillars' estimates are good, said mystery investor (for it is he) would possibly recoup the present capital loss on his position.

I generally take market reporting in the Guardian with a pinch of couscous... Interesting macro bigthink from some good people, but the Groin's investment writers are somewhat editorially hobbled.

Oh, and there I was last night, listening to the World Service. Live broadcast of the penultimate electoral debate between the most powerful leader in the world and his challenger. The debate was running long. Did the BBC alter schedule? They did not, they cut it short. So they didn't broadcast the summing up. Instead, I learned all about how a Tunisian feminist was expressing political activism through the medium of baking.

SwaziGold 18 Oct 2012 , 8:41pm

Tell me Key Life Skills do you use a spread betting for that?

Swazi Gold

KeyLifeSkills 19 Oct 2012 , 3:21am

Hi Swazi Gold,

No, I've never been interested in spread betting. I mainly invest in FTSE 100 companies but also hold several stocks in the FTSE 250.
I started in 1997 when I had to take very early retirement.
Over the years, I've been very fortunate in that I've managed to make a good living from investing.
I got lucky with Tesco last year - I sold our holding (15,000 shares) for a good profit in Oct, a few months before its big price drop. Since Jan 2012, I've bought and sold it many times and in terms of profit, Tesco, scores highly on my top 10 leader board for the year.
Occasionally, if the circumstances are right, I am willing to invest a larger percentage of our investment pot in one stock. My most recent profit was 40,000 shares purchased in June around £2.95-2.98 and sold between £3.44-3.48.
The share price has fallen of late and hit a low of £3.07 earlier this week before climbing again to close at £.3.20 today. I haven't bought into the recent fall. Instead, I've taken advantage of recent market rises and have been busy selling a big chunk of our portfolio.
In May, I also invested a higher percentage than usual in Randgold. Its share price has risen significantly but I intend to hold on to this stock for a while yet.

Regards,
kls

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