Tesco Drops Below £3

Published in Company Comment on 6 June 2012

The giant supermarket's shares drop below £3. Could it be a bargain buy?

Until the Eighties, Tesco (LSE: TSCO) was just another British supermarket fighting for shoppers' cash.

Tougher times for Tesco

In the Nineties, under the command of new chief executive and retail genius Sir Terry Leahy, Tesco began pulling away from the pack. Today, Tesco has a dominant UK market share of 30.8%, which is almost as much as those of Asda (17.4%) and J Sainsbury (LSE: SBRY) (16.5%) combined.

However, Tesco has had a bad 2012, with strong results abroad tarnished by weak growth in its home market, which accounts for nearly two-thirds (65%) of sales. As a result, Tesco shares have dived this year.

Five reasons to consider Tesco

As I write, they trade at 297p, having slipped through the psychologically important £3 mark earlier this morning. Here are five reasons why Tesco could be a bargain buy:

1. Market dominance

Investment guru Warren Buffett -- the world's third-richest man -- looks to invest in businesses with strong market dominance and wide 'competitive moats' around their business. For me, Tesco looks exactly the kind of firm that the Oracle of Omaha buys. After all, with worldwide sales above £72 billion, Tesco is the UK's grocery juggernaut.

To learn more about the mind and methods of the world's most successful investor, and to discover his favourite British business, please download your free copy of our latest report, The British Business That Warren Buffett Loves.

2. FTSE 100 giant

At 297p a share, Tesco's current market value is nearly £24 billion, making it the 20th-largest firm in the blue-chip FTSE 100 index. As a result of being one of Britain's corporate elite, Tesco's shares are incredibly liquid, so they are easy to buy and sell, even in large quantities. Also, as one of Britain's biggest brands, Tesco is widely held by leading fund managers.

3. Delightful dividend

Right now, you can buy Tesco shares, sit back and bank a forward dividend yield of 5.1%, covered a healthy 2.3 times. With the Bank of England's base rate stuck at a lifetime low of 0.5% a year since March 2009, this is a delicious yearly cash return for income-seekers and dividend fans.

4. Single-digit PER

What's more, their recent 'Big Price Drop' means that Tesco shares are rated at just 8.6 times forward earnings. Rarely do investors get the opportunity to buy corporate powerhouses on such low ratings. To me, Tesco's earnings yield of 11.6% (the reciprocal of the price-to-earnings ratio) is a sure sign that investors should fill their boots.

5. Growing sales

Although Tesco has had a few setbacks in the UK, its sales keep growing. In fact, in the year ending 25 February, total sales were up by 7% (and ahead 11% in fast-growing Asia).

In April, I weighed up Tesco based on 10 indicators, giving it a thumbs-up at 329p. With its shares now a tenth (10%) cheaper in the recent market slump, the company appears even more attractive today.

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> Cliff does not own any of the shares mentioned in this article. The Motley Fool owns shares in Tesco.

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Comments

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jf2007 06 Jun 2012 , 12:54pm

I am impressed with tesco's revaluating of their value range. I think now the Warren buffett effect has worn off and the shares are now below £3 they are quite cheap with good dividend

4spiel 06 Jun 2012 , 1:08pm

Tesco has a lot of competition in UK that is equally as good. The best buys in Tesco are only the daily sell offs. Its in China -do you trust China and they are slowing down fast. Tesco are not doing well in America. Yield nothing special -with extra UK costs to stand still dividend improvement nly likely on SP depreciation. When the divi gets to 6% it will have the right risk reward . Looking for £2.60

LastChip 06 Jun 2012 , 1:14pm

I've no quarrel with your analysis, but you're asking the wrong question.

It should be, when will the down trend stop and reverse?

Whether it's good value or not (and I'm not suggesting it isn't), you don't want to loose capital that could potentially take a long time to recover.

I, like you, thought it was good value at around 328p, but how wrong was I? On that bargain, I'm already down about 10%. OK, as it happens, I bought them for income and providing the dividends don't dry up, they're doing the business. But, if I'd waited a little longer and waited for a reversal, maybe I could have got even more out of them. Who knows, maybe they'll hit 250p; what then?

The more I play this casino, the more I realise it's all about the buying price and the trend, which in turn determines the risk/reward. Nothing else matters very much, other than huge amounts of debt. Substantial debt, I avoid like the plague. But I wouldn't suggest Tesco's debt is a problem.

TomRoundhouse 06 Jun 2012 , 1:36pm

Nothing would induce me to buy a share that is in a well defined downtrend. Fundamentals are there to inform a decision not drive it and please don't bang on about Graham and Buffet. The former operated in a world that is light years away today's and as for Buffet, despite his simple, folksy sayings he is a man of perhaps unique insight and trying to emulate him is arrogant in the extreme. I buy shares that are well and truly on the up, preferably after having been punished. I use fundamentals to put together a hit list but technical analysis to choose my moment.

SevenPillars 06 Jun 2012 , 2:20pm

It's unloved in an unloved sector. The city is f-rting around with small falls in this or that, like for like this, like for like that, meanwhile overall profits are higher this year than last, and the year before, etc, all in a time of austerity, when Tesco had further to fall than most because of its 30% of the UK consumer pound. What in heavens name does the city expect from this company? You cannot help but feel that they want to drive it down so that they, the big boys, can buy it up cheap for their pension and hedge funds, etc. To do that, they have to scare the little person out. They are doing a good job so far.

However, fundamentals do not matter when a trend for a share or sector is down. It can be relentless and devoid of logic, because that isn't the way the city behaves. 5 years ago the city was prepared to pay a premium for companies like Tesco and Sainsbury, but not today. Sainsbury has consistently outperformed city expectations for it, recently announcing its best Christmas results ever, yet its share price is half what it was five years ago.

The sector should be avoided until that city sentiment falls back in love with these companies. Until then, it doesn't matter what results these produce on the upside, the city will find a way to talk them down.

F958B 06 Jun 2012 , 4:03pm

SevenPillars

Yes, I think the average Joe is running for his life, bailing on Tesco in one of the greatest capitulations I've ever seen, comparable with the tobacco sector's and water sector's capitulation in 1999.
Interesting that now baccy and water are some of the most-loved sectors.
I'll read Tesco's Q1 trading update next week with great interest; I don't expect anything dramatic, and I'm looking to add to my holdings shortly afterwards when funds will be cleared.

sonrisa1 06 Jun 2012 , 4:03pm

Well I put my money in this afternoon, it really can not be worse than the derisory interest paid by banks to savers, if many more took their money out then they would have to raise interest rates?? I have threatened them & taken out quite a bit, risky?? I am risk averse but have calculatedwrongly or not??

BFTB 06 Jun 2012 , 4:15pm

One word for you: Amazon. That's the reason Tesco's share price is in the doldrums, the reason those white goods are not flying off the shelves in the new shop space they've opened, and everyone is bricking it that Amazon is going to encroach further and further onto Tesco's lawn.

SevenPillars 06 Jun 2012 , 6:36pm

BFTB - If you do a bit of research you just might find that it is Tesco that is encroaching further on Amazon's online lawn.

cduance 06 Jun 2012 , 7:39pm

Tesco actually sells lots of white goods via amazon at lower prices than in there own stores. I cant remember the alias they are selling under but there are several articles mentioning it. I thought Tescos fresh and easy brand was actually increasing in value and had sales increasing in the double digits.

jaizan 06 Jun 2012 , 7:58pm

Where's the economic moat?
When Tesco fail to provide decent service, I can go to Sainsburys, Asda, Lidl, Aildi, Waitrose, Wall Mart, CoOp, Budgens or the local market.

jaizan 06 Jun 2012 , 7:58pm

Sorry, meant Morrisons, not Wallmart.....

Smiley61 06 Jun 2012 , 8:02pm

Bought at 326, would be happy to buy more at 326 but kept some money back to pound-cost average.

Note that the drop in the share price is only slightly more than the drop in the FTSE100, so the performance of the market in general is likely to have more of an effect in the share price than the perception of TSCO as a whole.

nuages0 06 Jun 2012 , 9:39pm

Have you shopped there recently?

Apart from the proprietary products, like Kellogs & Heinz, the offerings of meat, fish, fruit, veg etc., are horrible. Poor choice & badly presented.

Not only that, the clientele is horribly down market. I feel as is if I might be mugged.

I honestly feel much more comfortable in Waitrose. That's it basically: Waitrose for quality, Aldi for value.

norfolkandgood 07 Jun 2012 , 12:24am

The clientele is horribly down market? Best you stick to Waitrose with the rest of the snobs then.

lameuse 07 Jun 2012 , 12:31pm

nuagesO - you sound a bit biased "Waitrose and Aldi, but not Tesco"? I agree that Waitrose feels safe and sound, pretty, etc but I fail to see how Aldi would feel more congenial than Tesco.
But there is an 'anti Tesco' feeling about which might be chopping a few pence off the price of each share...

apprenticeDRL 07 Jun 2012 , 12:31pm

Personally I think Morrisons fresh fish and vegetables are the best of the lot.

I live in the West Country and Tesco also offers a good fresh fish counter and vegetables, our local Waitrose has not been a roaoring success.

With regard to the clientel I would guess that probably depends where you live. The clientel in our local Tesco's ( and we have 3 large stores within a 15 minute drive) are mainly middle Britain at a guess.

Clitheroekid 07 Jun 2012 , 8:02pm

Not only that, the clientele is horribly down market. I feel as is if I might be mugged.

I suspect this is far more a reflection of where you live / shop than of Tesco generally. Like all major supermarkets they have to position some stores in grotty areas.

However, whilst you may be unfortunate enough to live / shop in some mugger-infested slum it displays a somewhat limited imagination to assume that all the other Tesco stores are situated in similar areas.

And Waitrose is hardly a valid comparator. With less than a sixth of Tesco's sales it has always positioned itself at the affluent end of the market and located its stores accordingly. However, that market is very limited, and Waitrose is likely to find that its ability to expand is equally limited.

goodlifer 08 Jun 2012 , 11:16pm

TomRoundhouse
"Please don't bang on about Graham and Buffet. The former operated in a world that is light years away today's and as for Buffet, despite his simple, folksy sayings he is a man of perhaps unique insight and trying to emulate him is arrogant in the extreme."

I don't know about "emulating," but I'm arrogant enough to think Warren Buffet's views deserve at least as much attention as those of any amateur or professional Fool I can think of.

As for Ben Graham, you're absolutely right to suggest that the mechanics and electronics of investment have changed enormously since the 1840s.
But Ben's strong point is, it seems to me, his understanding of human nature.

How much has human nature changed since Ben was in his prime?

goodlifer 08 Jun 2012 , 11:21pm

Sorry, typo - should have said 1940s!

spreadbutter 09 Jun 2012 , 1:58pm

How anyone can try to argue that fruit and veg is better in one supermarket, such as Waitrose, over that found in Tesco or Asda is beyond me!? You few, who argue this point, should, for at least once in your future life, try supporting local street traders - by buying fruit and vegetables from market stalls, up and down the UK, for an indicator of just how exponentially better, quality, non-supermarket fruit and veg can taste. What's more, since abandoning buying fruit & most veg from supermarkets, I've also found that market stall prices for undeniably better tasting produce is invariably far better value than that offered in any of the supermarkets. Yes, I most definitely became tired of buying fruit and veg, most of which taste no better than watery paper, from supermarkets (including the one which many people claim is supposedly a 'cut above' the others...)! Reality = All supermarkets, bar none, are buying the very, very cheapest quality fruit, which is artificially produced with the main priority to look perfect on shelves for as long as possible (at the expense of taste!) and then trying to knock it all off at 'smoke and mirrors' prices, by deploying the usual two for one tricks etc., & all thanks to the gullibility of the masses. That all being said, are Tesco a buy at these levels? Probably.

johnthai 10 Jun 2012 , 5:00am

It is clear to me that Tesco have taken their eye off the ball in the fresh food segment of their stores. This is not only in the UK but in other international markets. However, regardless of the location of Tesco's stores and whether these tend to be high or low income areas, isn't one persons pound equal to another's? As a shareholder, it makes no difference to me what the person spending the cash earns, just where they spend it. In Asia, Tesco has massive growth opportunities an I suspect that they will take full advantage of this.

F958B 10 Jun 2012 , 2:53pm

spreadbutter

re:food quality at supermarkets.

Yes, on a tangent but interesting, is that nutritional content of many fruit and veg is much lower nowadays due to un-natural growing techniques, premature harvesting (first to market gets the best price) and varieties bred for weight of yield and not necessarily for highest nutrition - many crops are very much plumped-up with heavy irrigation, but without a proper balance of nutrients.
In some crops, it is reckoned that the nutritional content is down by three-quarters in the last hundred years.

I grow a significant amount of my own fruit and veg spray-free (I also have a collection of rare old fruit trees - three quarters of which most people will never have heard of - and I graft/propagate a few for family and friends), and those people who used to laugh and mock me are now also growing their own - they have been stunned at the difference in flavour between home-grown old varieties of fruit and veg, compared to commercially-produced supermarket food.

So for real quality fruit and veg - and cheapness - grow your own.
But don't grow the same types as sold in the shops because they lack flavour, lack nutrients and tend to be difficult to grow with dozens of chemical treatments every season to keep them healthy.

Many local recycling centres offer free recycled composts and manures - just turn up with a car, a few sacks and a shovel and take all you want for free. It's excellent stuff for growing plants, or scattering a thin layer across the garden to boost soil fertility.

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