Tesco (TSCDY, Financial) has been selling well short of the price Warren Buffett paid last year. In November he paid some $18 a share and it now sells for less than $15 (a P/E less than 9). The remarkable thing is how unchanged the business is despite the sell-off. What catalyzed the sharp drop in price was comments by the CEO that earnings growth would be muted for 2012. But what I’ve discovered, as Warren Buffett certainly has, is that the company is an exceptional business selling at a very attractive price.
First the bad….
Tesco continues to tough out the challenging UK market and this has been the primary concern among investors. The company has been parachuting in some of their more talented managers from its foreign operations in order to fix their domestic troubles. Tesco announced it would create some 20,000 new jobs in the UK to improve upon its customer service which has lacked of late. The UK magazine The Grocer recently released a loyalty survey of British grocers. Tesco, the one-time leader in loyalty through its Clubcard program, came in at an abysmal 8 out of 10 for the loyalty ranking. The magazine wrote of Tesco:
“Tesco is neck-and-neck with Asda [a Wal-Mart subsidiary] on good quality at good prices, the leading loyalty metric. But it massively trailed its rival on ‘low prices’, with only 8% of shoppers saying this was the key factor that would make them recommend the store.”
And then the growth segments…
Tesco has shed market share in grocery of late though it still holds a commanding 30% of that UK market. But where it struggles in brick-and-mortar it steamrolls online. The company captured some 48% of the online grocery market and is growing at 14%. It expects to double its £5.5 billion sales over the next five years. For Americans unfamiliar with the UK grocery market, the country is a couple steps ahead of us in term of online use as this video will show.
The UK grocery market:
Tesco International
As the company stumbles in the UK, its international operations have picked up the slack. Tesco gets 22% of its profits from international operations, up from 5% 10 years ago. And just as in the UK the company doesn’t just make sales in foreign markets, it dominates those markets. Tesco is No. 1 in the UK grocery market, but it also ranks No. 1 or No. 2 in 9 international markets.
South Korea
Tesco’s Homeplus operation was one of the Tesco’s first foreign expansions and also one of the most successful. In one of the countries where both Wal-Mart and Carrefour had withdrawn, Tesco grew a joint venture with Samsung with all of two stores in 1999 to become the No. 2 retailer in the market today (Tesco has since bought out Samsung). Tom Brown, a director for Tesco Homeplus, credits the joint venture structure with the success of the South Korean operation. In an interview (a must-read for any Tesco investor) he notes that Tesco’s best overseas businesses are ones where a local partner is involved. Further, he notes that Wal-Mart and Carrefour both perform poorly in terms of adapting to the local culture. In 2011 Tesco pulled down £300 million in profits from £5 billion in sales from Homeplus.
Thailand
Tesco recently launched a $600 million property fund in Thailand to finance the construction of malls in the country with Tesco Lotus as the anchor tenant. The fund is organized such that Tesco will turn around and lease back the property allowing the company to preserve capital that would’ve otherwise been spent on real estate and focus on its niche – selling goods and maintaining its No. 1 position in Thailand.
U.S.
The Fresh & Easy chain is not one of the dominant markets for Tesco, but it is set to break even sometime in 2012. The subsidiary has been one of the less profitable ones for Tesco, losing some $1.11 billion since 2007. Twelve underperforming stores have been closed and Tesco’s CEO has not ruled out either selling the chain or forming a joint venture.
Tesco tripled its earnings per share over the past decade and averaged returns to equity in excess of 15%. It is remarkable for a business like this to sell for less than a P/E of 9 especially given the overall company outlook. Sure the UK business is stagnating, but company-wide earnings continue to grow and the CEO himself expects this year’s earnings to increase albeit modestly. I'm not going to be praying for a higher stock price though. If in a year's time Tesco continues to sell for $15, it just makes the job of finding sound investments that much easier.
Disclosure: Long Tesco (TSCDY)
First the bad….
Tesco continues to tough out the challenging UK market and this has been the primary concern among investors. The company has been parachuting in some of their more talented managers from its foreign operations in order to fix their domestic troubles. Tesco announced it would create some 20,000 new jobs in the UK to improve upon its customer service which has lacked of late. The UK magazine The Grocer recently released a loyalty survey of British grocers. Tesco, the one-time leader in loyalty through its Clubcard program, came in at an abysmal 8 out of 10 for the loyalty ranking. The magazine wrote of Tesco:
“Tesco is neck-and-neck with Asda [a Wal-Mart subsidiary] on good quality at good prices, the leading loyalty metric. But it massively trailed its rival on ‘low prices’, with only 8% of shoppers saying this was the key factor that would make them recommend the store.”
And then the growth segments…
Tesco has shed market share in grocery of late though it still holds a commanding 30% of that UK market. But where it struggles in brick-and-mortar it steamrolls online. The company captured some 48% of the online grocery market and is growing at 14%. It expects to double its £5.5 billion sales over the next five years. For Americans unfamiliar with the UK grocery market, the country is a couple steps ahead of us in term of online use as this video will show.
The UK grocery market:
Tesco International
As the company stumbles in the UK, its international operations have picked up the slack. Tesco gets 22% of its profits from international operations, up from 5% 10 years ago. And just as in the UK the company doesn’t just make sales in foreign markets, it dominates those markets. Tesco is No. 1 in the UK grocery market, but it also ranks No. 1 or No. 2 in 9 international markets.
South Korea
Tesco’s Homeplus operation was one of the Tesco’s first foreign expansions and also one of the most successful. In one of the countries where both Wal-Mart and Carrefour had withdrawn, Tesco grew a joint venture with Samsung with all of two stores in 1999 to become the No. 2 retailer in the market today (Tesco has since bought out Samsung). Tom Brown, a director for Tesco Homeplus, credits the joint venture structure with the success of the South Korean operation. In an interview (a must-read for any Tesco investor) he notes that Tesco’s best overseas businesses are ones where a local partner is involved. Further, he notes that Wal-Mart and Carrefour both perform poorly in terms of adapting to the local culture. In 2011 Tesco pulled down £300 million in profits from £5 billion in sales from Homeplus.
Thailand
Tesco recently launched a $600 million property fund in Thailand to finance the construction of malls in the country with Tesco Lotus as the anchor tenant. The fund is organized such that Tesco will turn around and lease back the property allowing the company to preserve capital that would’ve otherwise been spent on real estate and focus on its niche – selling goods and maintaining its No. 1 position in Thailand.
U.S.
The Fresh & Easy chain is not one of the dominant markets for Tesco, but it is set to break even sometime in 2012. The subsidiary has been one of the less profitable ones for Tesco, losing some $1.11 billion since 2007. Twelve underperforming stores have been closed and Tesco’s CEO has not ruled out either selling the chain or forming a joint venture.
Tesco tripled its earnings per share over the past decade and averaged returns to equity in excess of 15%. It is remarkable for a business like this to sell for less than a P/E of 9 especially given the overall company outlook. Sure the UK business is stagnating, but company-wide earnings continue to grow and the CEO himself expects this year’s earnings to increase albeit modestly. I'm not going to be praying for a higher stock price though. If in a year's time Tesco continues to sell for $15, it just makes the job of finding sound investments that much easier.
Disclosure: Long Tesco (TSCDY)
