After struggling for more than two years with falling sales,Tescos(LSE: TSCO) recovery finally seems to be gaining traction.
Indeed, Tescos first-half report was full of positive figures. The volume of goods sold at Tescos stores rose 1.4% during the period, and the number of transactions rose 1.5% as Tesco started to win back customers. Further,in the six months toAugust 29, Tesco generated free cash flow of 281m, compared with a 134m outflow in the year-earlier period. Many City analysts werent expecting Tesco to generate any cash at all.
Asset sales have also helped to get Tescos debt under control.
Still, its clear that Tescos sales will continue to contract for the foreseeable future as, while the company is reporting an increasing volume of goods sold, food deflation is pushing prices down across the grocery sector. To offset this decline, Tesco could decide to go all-out and make a bid for one of its smaller peers,Sainsburys(LSE: SBRY) orMorrisons (LSE: MRW).
This proposal isnt as ludicrous as it first appears. Using some financial alchemy, Tesco could actuallyimprove the state of its balance sheet bybuying one of its smaller peers and boost sales at the same time.
For example, both Morrisons and Sainsburys are both valued at less than the value of the property on their balance sheets, indicating that it is cheaper for Tesco to buy one of the companies than build the extra capacityitself.Sainsburys property is worth 9.6bn, and Morrisons real estate is worth 7.3bn, compared to market caps of 4.9bn and 3.6bn respectively.
To make the most of any deal Tesco would need to make its offer for Sainsburys or Morrisons an all-stock transaction, or 75% stock with a 25% cash kicker. An all-stock deal would give Tesco more financial flexibilityas,when the deal completes, the supermarketgiant would be able to sell a portion of the acquired real estate to pay down debt. In many towns and cities theres an overlap between Morrisons and Tesco stores catchment areas, soselling stores with an overlap wouldnt cost Tesco too much regarding sales. Selling half of Morrisons real estate (3.7bn) would allow the enlarged Tesco to pay off debt acquired from Morrisons (2.5bn) and pay down an additional 1.7bn of Tescos legacy debt. Moreover, the deal would boost Tescos sales by over 8bn (after factoring in 50% store sales) and could increase group free cash flow by 40%.
Acquiring Sainsburys could be even more beneficial for Tesco. As Sainsburys balance sheet is much stronger than that Morrisons with only 2.8bn of debt and 9.6bn of real estate, Tesco, the acquirer, could raise 4.8bn from property sales, using 2.8bn to pay off Sainsburys acquired debt and 2bn to pay off legacy debt.
Still, these figuresare only estimatesand before making a trading decision, you should conduct your own research to see if the company in question is suitable for your portfolio and financial goals.
To help you assess potential investments for yourself, our top analysts have put togetherthis report, which guides you through thetenessential steps you need to take to become a stock market millionaire.
Thereport explainshow spending just 20 minutes a month could help you create a portfolio that could bring you closer to financial freedomfor life.
Click hereto check out the report–it’s completely free and comeswith nofurther obligation.