Tesco gets a new boss – but it’s not time to buy yet

Tesco’s chief executive, Phil Clarke, is on the way out. He’s failed to turn around the supermarket giant.

And to add insult to injury for Clarke, the share price has bounced – even although Tesco has also issued a profit warning – with sales and trading profits for the first half “somewhat below expectations”.

Dave Lewis, a senior executive at consumer goods giant Unilever, is taking the reins. Lewis is the first ‘outsider’ ever to be appointed as Tesco boss. Until now, he’s spent his whole career at Unilever.

He successfully turned round its Irish business a few years ago, and is currently the boss of the ‘personal care’ division. And investors are impressed by his ability to build brands, according to The Telegraph. That could prove useful, as there’s no doubt that Tesco’s brand has been tarnished in the eyes of at least some consumers.

But can one man turn Tesco around? Or is there a bigger problem here?

So should you buy the shares?

It’s not hard to make a ‘buy’ case for Tesco. After this morning’s 6p rise to 291p, the shares trade on a price/earnings ratio of 12.8 with a 5% yield, so Tesco looks cheap at first glance.

What’s more, my colleague, Bengt Saelensminde reckons that Tesco could be ‘a great turnaround play’ with the potential to become a ‘dotcom giant’.

However, I’m not convinced. The trouble is that Tesco has invested huge amounts in large out-of-town stores, and many of these stores are no longer performing that well.

That means Tesco isn’t getting a great return on its investment. Indeed, according to Stockopedia, Tesco’s return on equity is currently 11.9%, which isn’t great.

As Matthew Lynn noted in MoneyWeek magazine last month: “The hard truth is that [the big supermarkets] built too much capacity during the boom years”. Now they’re lumbered with assets that aren’t generating a decent return.

Tesco’s other big problem is that it’s traditionally had a generous profit margin of around 6%. That’s a high margin in food retail, and although it was nice for shareholders to have for a long time, it left Tesco vulnerable to competition from the likes of Aldi and Lidl at the budget end of the market.

I fear that Tesco will struggle to return to its glory days.  Lewis may be a very talented executive, but in the end, he’s probably going to have to close some stores and cut margins. With that background, it will be hard to grow profits at any kind of speed. That means the shares could have further to fall.

Merryn

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