Tesco - Every Little Helps
Tesco is a multinational grocery and merchandise retailer based in the UK. Based on revenues, Tesco ranks number three among the world’s largest grocers just behind Carrefour in France and Wal-Mart in the U.S. Tesco is also located in over a dozen other countries around Europe, Asia, and North America.
The company’s shares took a dive in January after management issued a profit warning due to their struggling UK business. Management admitted to running a little too lean, which suggests margins may be further compressed in the future. Since the UK market represents about 2/3 of Tesco’s profits, signs of margin compression for the short and middle term sounds daunting. As the Eurozone continues to struggle economically, this could negatively affect profits, especially in their non-food segments where consumers may take austere measures to reign in spending on discretionary items.
However, Tesco maintains a crucial advantage in that it is twice the size of its UK competitors, with a market leading 30% share of the grocery market, and in this business, scale is everything. In addition, Tesco has been able to partially offset the domestic margin issue with rapid growth internationally, especially in Asian countries such as Thailand, Malaysia, and South Korea. As the company’s slogan suggests, “Every little helps!”
Despite signs of future margin compression and depressed profits, Tesco’s recent market price provides a large margin of safety. At recent prices, the company was trading below 9x trailing earnings. However, as earnings decline we take comfort knowing Tesco owns about 75% of their real estate, which at recent prices means Tesco was trading below the value of the brick and mortar alone.
Tesco definitely has some headwinds to face in the future, but its recent price provides a large enough margin of safety to make a compelling case for an investment.
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