A year ago, with the shares at 210p, I was bearish on Tesco(LSE: TSCO).Today, with the shares down to 147p, I remain bearish on the supermarket giantand see potential for the shares to fall by half from here to around 70p.
This is why
Tesco seems unlikely ever to return to former glories. The supermarket chain was built and became dominant in an era when the food retailing landscape was different. Back then, the firms business model worked.
Now, the ferocious attack from upstart low-costrivals such as Aldi and Lidl has forced giants like Tesco into retreat. Tesco has halted its expansion programme in the UK, is selling off assets as fast as it dares to, and has engaged the lower-cost chainshead-on in a price battle. Thats a poor set of circumstances, which makes it even harder than it was before for Tesco to thrive. And thats really saying something, because the supermarket business has always been very competitive.
We gained a strong flavour of the depth and breadth of the daunting challenges facing Tesco when the firm released its interim report back in October. The companyset out its three key priorities:
- To regain competitiveness in its core UK business.
- To protect and strengthen its balance sheet.
- To rebuild trust and transparency.
These are big issues. A firm doesnt have much going for it when it has lost its competitive advantage, has a weak and threatened balance sheet, and when its customers, investors and partners no longer trust it.
Theres no magic fix for this. Tesco needs to be rebuiltfrom the ground up. The firms very culture needs to change, but I fear that its already too late and we may be seeing the start of managed decline for this once-mighty Goliath.
A pricey valuation
Of course, Tesco is trying to turn itself around. A series of cost-cutting measures and changes in operational practice will have some effect in the short term. Indeed, City analysts following the firm expect earnings to rebound by as much as 78% for the year to February 2017. However, such growth in earnings seems likely to be transitory. Forthe long haul, Id wager that Tesco is likelyto struggle to grow its earnings.
Despite the firms problems, investors keep the shares on a forward price-to-earnings rating of about 16. Thats a severe case of counting chickens before theyve hatched. Why give a firm the benefit of the doubt when it has just proved its ability to underperform? Turnaround hopes seem misplaced here, and in any case Id set the firms rating at about eight half what it is now and allow for upside surprises rather than downside shocks. Thats why I think Tesco is only worth about 70p per share today.
I continue to avoid Tesco and the rest of the supermarket sector in favour of stronger investment propositions elsewhere.Thefive shareschosen by the Motley Fool’s analystsmake good candidates for further research and remain strong and well placed in their industries.
Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.