Analysts to Downgrade Tesco

Tesco on August 29 issued yet another profit warning and cut its interim dividend prompting equity analysts to reconsider the stock's fair value estimate

Ken Perkins 1 September, 2014 | 9:17AM
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Tesco (TSCO) on August 29 issued yet another profit warning and cut its outlook for trading profit to £2.4 billion - £2.5 billion, down about 15% from previous expectations of about £2.9 billion. The company also cut its interim dividend by 75% to 1.16p per share, bringing the full-year dividend down a little less than 25% to 11.29p, affirming our no-moat rating and our concerns that intense price competition could prompt the firm to rebase its profit margin and cut its dividend.

We think these moves should give new CEO Dave Lewis more flexibility to address the issues that Tesco faces. Rivalry remains very high in the U.K. grocery market, as the resurgence of discounters Aldi and Lidl in the U.K., as well as the emergence of high-end grocer Waitrose, has left Tesco and other traditional grocers stuck in the middle, scrambling to fight for market share. Tesco has been disproportionately affected by recent changes in the marketplace, as it also has relatively more exposure to large hypermarkets, a format that has been challenged by customer migration to the convenience and online channel. If consumers continue migrating to other channels, Tesco may struggle to maintain historic productivity and profitability levels at its large stores.

We intend to update our forecasts for Tesco and foresee a 10%-15% decrease to our GBX 360 fair value estimate. However, we still think that Tesco will remain a dominant player in the U.K. grocery market, and we believe shares are undervalued at current levels. Tesco should be able to run enough volume through its distribution network to generate healthy cash flows once market trends stabilize, but unfortunately, there are few, if any, identifiable catalysts that suggest that market stabilization is just around the corner. As such, we recommend Tesco only to investors who are not only looking for exposure to the U.K. grocery space but who also have long investment horizons and high risk tolerance.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Tesco PLC353.40 GBX0.71Rating

About Author

Ken Perkins  is a Morningstar equity analyst covering consumer packaged goods firms.

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