Analysis – Tesco

British worldwide operating supermarket chain Tesco (ISBN: GB0008847096) grew up to the largest player on the island and worldwide number three after Walmart (USA) and Carrefour (France). Currently, shares offer a 5 % dividend yield and a historically low price-earnings-ratio (PER) below 10.

Investment Case Summary

1. Leadership & Corporate Culture

  • Overall workforce: Most hand work in shops.
  • Board courage to use new sales technologies. E.g. scan-as-you-shop or customer-scan-and-pack.
  • Unprofitable shops closed fast & unemotional (e. g. Japanese business).
  • CEO Philip Clarke were since 1998 at Tesco. New one Dave Lewis from Unilever will start tomorrow.
  • Dave Lewis is not a retailling expert, but certainly knows a lot about consumer products and costs. Known as ‘Drastic Dave’ cutting 300 jobs in 2007 at Unilever.
  • Usually no external appointment at Tesco for C-Suite. Could show problems with aimed strategic direction.

arrow-right-aRetail giant with unemotional board. Recent CEO changes bear both, new risks and chances.


2. History & Status Quo

Diversification within company:

  • Activities in the UK, US, China, India, the Czech Republic, Hungary, Ireland, Malaysia, Poland, Slovakia, South Korea, Thailand, Turkey and Japan.
  • Market leader (based on sales) in Thailand, Korea and UK.
  • Bank retail services and insurances (Tesco Bank). Reputation seems to be better as huge english banks, due to existing customer relations.
  • Many own brands (common for large scale chains, due to strengthen brand loyalty and higher margins).

Finance status:

  • Conservative, low debt usage with 43 % debt out of total capital.
  • Good cash flows.

Observed growth and growth source:

  • Steady and profitable growth between 2005 and 2012. Esp. in Asia.
  • Major sales and income of 2/3 in UK. So, heavily dependent on UK national economic situation (unemployment, national debt, …) and UK retail market competition.


  • Geometric net income growth between 2005 and 2012 at approx. 9.6%.
  • 2013 net income nearly zero, due to both, fall in demand and huge investments.
  • Retail performance indication by operating income shown below.


  • Only slow recovery from 2013 drop. New estimation for 2014 between 2.4 and 2.5 bn GBP (lower than in graph).
  • Bargaining power: Tesco pay supplier for goods several weeks after they have soled and received payments from customer.
  • During reading financial statements we recognised huge pension accruals. Why that? (work in progress)

Competition / market players:

  • Heavy worldwide competition, not easy to explore new markets. Compare Walmarkt approach to Germany.
  • Online shops (Tesco Direct). More analyse needed here (work in progress).
  • Large, small “Tesco Extra” and medium size stores running. Allows Tesco to operate in different environments.
  • Best UK retailer margins today, since of scaling.
  • UK food retail has barriers to entry due to the economies of scale of the incumbent market leaders.
  • Nevertheless, recent market entrance of Aldi and Lidl. Both growing fast. Especially Aldi plays a hard price competition as in Germany. In German market no retailer beats Aldi on prices. German retail market involves one of the lowest retailer margins in Europe.
  • Due to the market environment, interim dividends 2014 are cut by 75%.

arrow-right-aWell diversified food retailer, but still highly dependent on UK homemarket. Aldi and Lidl entered the market. Both play a hard-line price competition due to their bespoke value creation process. Steady past income observed, but heavy to derive future income and growth.

3. Sustainable Core Competence

  • Economies of scale, mainly in UK, gives company a competitive advantage (like Walmart).
  • Operational large-scale business procedures.
  • Fast opening and small shops enable fast market testing.
  • Customer’s habits are somewhat sticky and they often shop in the supermarket closest to them.

arrow-right-aCore competence given by large-scale sales and forced high margins in UK. Both, depend on customer habits and loyality.


4. Fair Price with Safety Margin

  • Historically cheap. Current price level from 2004.
  • Due to personal changes and new aggressive market players, future growth cannot be deduced from history.
  • We deduce market expectation for growth, based on our own investment criteria.

Derivation of assumptions for eternal dividend growth (G):

  • R = Required long-term yield of 8%. Corresponds historical long-term stock yields in Europe/US. Plus safety margin, so we use 10%.
  • NPV = Net present value. We set this to the current market price 2.3 GBP.
  • D_{2014} = Dividends 2014. We use 0.4 GBP per share from 2012.

Gordon Growth Model:

  • Calculation in GBP
  • R_{safetymargin}=10%
  • NPV=2.3 GBP (30. August 2014)
  • D_{2012}=0.4 GBP

G_{market, safetymargin} = \frac{NPV \cdot R_{safetymargin} - D_{2012}}{D_{2012} + NPV} = \frac{2.3 \cdot 0.1 - 0.4}{0.4 + 2.3} = -0.06 < 0

arrow-right-aWith given long-term assumptions (incl. safety margin) market participants expect an eternal income decrease of 6 %, based on 2012 dividends.

Summary & Key Findings:

  • New non-retail-expert CEO Dave Lewis faces huge challenges.
  • Well diversified food retailer over store types, but highly dependent on UK home market.
  • Aldi and Lidl entered the market. Both play a hard-line price competition.
  • Steady past income observed, but heavy to derive future income and growth.
  • Top-or-Flop Stock / turnaround bet: If Tesco would growth (slowly), the stock would change to the old track. But, if the new management cannot find a sustainable solution for Tesco, as the market expects, the company will shrink gradually.

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