What's the Next Step for Tesco?
08/23/2013 12:00 pm EST
Everyone's always looking for the very best buying and selling opportunities in today's uncertain market, and here to help you analyze the long-term prospects of a multinational retailer is Zarr Pacificador, from The Motley Fool UK.
I'm always searching for shares that can help ordinary investors like you make money from the stock market.
Right now I am trawling through the FTSE 100 and giving my verdict on every member of the blue-chip index.
I hope to pinpoint the very best buying opportunities in today's uncertain market, as well as highlight those shares I feel you should hold...and those I feel you should sell!
I'm assessing every share on five different measures. Here's what I'm looking for in each company:
- 1. Financial strength: low levels of debt and other
- 2. Profitability: consistent earnings and high profit
- 3. Management: competent executives creating shareholder
- 4. Long-term prospects: a solid competitive position and
respectable growth prospects, and;
- 5. Valuation: an underrated share price.
A look at Tesco
Today I'm evaluating Tesco, a British multinational retailer, which currently trades at 363p. Here are my thoughts:
- 1. Financial strength: Tesco is in solid financial
position. Net debt/operating cash flow is less than 2 times; net gearing is
50%; interest cover is an adequate 7.5 times; and free cash flow has averaged
nearly £2bn per year over the last 3 years.
- 2. Profitability: Tesco has delivered outstanding growth
for nearly two decades. However, with the continuing weakness in Europe and
facing stiff competition at home, the company has struggled of late. In the
last fiscal year, underlying profit before tax declined by 15%, while
underlying earnings per share fell by 14%. Forced to compete in price, the
company's margins have contracted from to 3.4% from 5.6% the previous year.
Also, international trading profit declined by 22%, due to the impact of
regulatory changes in South Korea and impairment of businesses in Turkey,
Poland, and the Czech Republic.
- 3. Management: I believe the company's new direction
under Philip Clarke, which focuses on developing its multichannel
footprint, strengthening its core UK business, and adopting a more prudent
international growth strategy, places the company in a better position moving
- 4. Long-term prospects: Tesco has fallen out of favor
with investors recently after a rough 18 months, where it was rocked by the
horsemeat scandal, several quarters of declining market share and
like-for-like sales, and write-offs of its Fresh and Easy US business
and several UK properties of more than £1bn and £804m, respectively. However,
despite the grim outlook, I believe Tesco's competitive position remains
solid. It is still the largest UK grocer with a market share of 30%—almost
doubling that of its closest rival Wal-Mart's ASDA. It also owns the UK's
widest store network, with around 3,000 stores and the world's largest and
most profitable online supermarket, which reached a record-high revenue of
over £3bn last year. In addition, it is the number one or two retailer for
general merchandise in eight out of nine of its international markets.
Furthermore, to adapt to the rapidly changing retail environment, the company
has announced new strategic objectives which include: a shift from traditional
large-store formats to building its multichannel retail capabilities,
such as convenience and online retailing; focusing on its core UK operations
to maintain its leading position—the company has invested around £1bn to
overhaul its superstores; and adopting a more disciplined approach to
international expansion, concentrating only on markets that could deliver
strong investment returns.
- 5. Valuation: With a market cap of £30bn, Tesco trades at
a forward price-to-earnings (P/E) ratio of 11—slightly below its 10-year
median P/E of 13 and the industry average of 12—and a prospective dividend
yield of 4%, twice covered.
My verdict on Tesco
Although recent results have been disappointing and with competition in the UK likely to remain competitive, I think the company still owns a distinct advantage with its scale and size. Also, its profitable international business—29% of the company's profits come from outside the UK—and established online presence could be a source of future growth opportunities.
Moreover, the company intends to tighten capital spending during the next few years—around 3.5% to 4% of revenue—which will add to its already strong cash flow. What's more, shares are trading at an undemanding P/E of 12, a discount compared to its peers Wal-Mart and Carreouflour. So overall, I believe Tesco at 363p looks like a buy.
Zarr does not own any share mentioned in this article. The Motley Fool owns shares in Tesco.