Tesco’s recent spat with Unilever is all about the consequences of Sterling’s recent weakness following the Brexit vote. As the costs of imported goods start to rise in the coming months, supermarkets like Tesco are all too aware of the potential hit to their profitability. They will be wary about asking consumers to pay more and their suppliers will also be reluctant to take less for the goods they are supplying.
Tesco’s profitability is of key concern to investors and as one of Britain’s biggest companies, Tesco and its finances are subject to intense scrutiny.
Investment managers employ different strategies when trying to select suitable companies in which to invest, in order to generate returns for their investors.
Value Investing is a strategy has fallen out of favour in recent years as many managers are not willing to commit to the often longer timescales that this particular discipline requires. Holding periods for many FTSE100 stocks have reduced to around 7 months on average.
Instead of trying to make quick random profits, value investment requires patience, detailed research and insight. Primarily, value investment is about identifying companies who are basically sound and ultimately solvent, but who have for some reason fallen out of favour with investors. This could be as a result of temporary conditions, economic cycles or as a result of some scandal that has damaged the company’s reputation and therefore the trust of the market.
A couple of years ago, my colleague Jilly Mann and I met up with Nick Kirrage, a dedicated value investing fund manager at Schroders. We have been holding investments for our clients in Nick’s funds for many years now via the Schroder Recovery and Schroder Income funds. During our catch up discussion, Nick provided us with a good example of a company that has fallen into the value category and as a result it is now one of the many companies that they invest in.
For many years Tesco was the darling of the FTSE100. Led by its charismatic Chief Executive, Sir Terry Leahy, it could seemingly do no wrong. Between 1996 and 2008, its share price rose from around a £1 to nearly £4 per share. Year after year it announced yet more success and even bigger profits. The problem was that after a while, the market came to expect this continued growth and expansion as being the norm and so the pressure grew on the executives within the company to match the hype of the market expectations. Sadly this resulted in Tesco taking more and more aggressive tactics in order not to disappoint. Suppliers were pressurised, accounts were distorted and eventually it became clear that all was not well at the heart of one of Britain’s biggest companies. In 2014 a series of news stories in the media finally resulted in an admission by the company that there was a problem with its accounts. The company’s share price fell through the floor and the then chief executive, Philip Clarke, fell on his sword. However, after 2 years of seemingly relentlessly negative news flow, it seems that Tesco is now marching down the road to redemption. The new chief executive, Dave Lewis, has been busy restructuring the company. All the bad news appears to be out there now and he has been busy selling off the peripheral holdings and the overseas businesses in order to raise capital and to focus on the core business.
From a value investment perspective, Tesco is a classic case. Regardless of whether or not you like shopping at Tesco, it is difficult to argue against its dominance in its sector. Tesco has a 30% share of the UK market, this is double the size of its nearest competitors, Sainsburys and Asda which each have a 15% share. Although Aldi and Lidl are growing fast, they each only have a 6% share.
Keen share price watchers will have noticed that Tesco’s share price has risen 12% over the last week and is now at £2 per share in response to news that the measures Dave Lewis has been putting in place are beginning to bear fruit. The Tesco share price may or may not get back to the dizzy heights it reached back in 2008, but patient investors will take the odd rise here and there. Together with a dividend yield of 6% you could do a lot worse. If the share price goes back to £2.80 per share, which looks achievable in the not too distant future, patient value investors who bought Tesco at £1.40 per share will have doubled their money.