Tesco: is this a huge buying opportunity?

published 13 January 2012

Gosh. What went wrong for Tesco yesterday?

Judging by the share price plunge, you might suspect that it had announced a massive product recall. Or that its US business had collapsed. Or that it had turned out to have owned a dodgy oil rig somewhere in the Gulf of Mexico.

Nothing so dramatic. All that happened on the surface at least - was that Tesco had a pretty rubbishy Christmas.

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So is this a massive buying opportunity? Or is your money better off elsewhere?

Christmas was anything but merry for Tesco

Tesco (LSE: TSCO) shares closed the day down 16% yesterday, at 327.5p. To put that into some perspective, their 2009 low was around 306p a share. The lowest point they hit directly after the Lehman Brothers crisis (when everyone thought the financial world was ending) was 285p, in November 2008.

And they've continued to fall this morning. Just how bad was that trading update?

Pretty poor, is the answer. Like-for-like (ie excluding new stores) sales in the UK fell by 2.3% in the six weeks to January 7. Given that 2010, when we were all snowed in, shouldn't have been hard to beat, that's a really awful result.

The company admitted that while it had slashed prices in a "highly promotional market", it hadn't attracted enough customers from its rivals to offset the cost of that. As a result, profits will be at the low end of expectations this year.

But next year (2012/13) is the real problem. Tesco expects virtually no profit growth, as it invests in refreshing stores and product ranges at its UK business, to take back market share from its rivals. Analysts had expected growth of about 10%.

On top of that, management indicated that they won't be building as many big stores, focusing on the internet for selling non-food items instead.

So while the scale of the fall might reflect a jittery market in part, there's no doubt that this was a big deal. Philip Clarke, the new-ish chief executive, has finally turned around and said that the Sir Terry Leahy days are over. Now there's a new strategy in town.

Suddenly Tesco looks vulnerable. It's being mauled by its rivals in its still-critical UK market. In the non-food market, it's increasingly clear that its main rivals will be the likes of Amazon - and who wants to compete with Amazon?

Outside the UK, there are "signs of caution", and despite solid sales growth, the key US operation is still an unknown quantity. Given that the management focus in the coming year will all be on the UK, can those businesses really thrive and grow in what remains a very wobbly global environment?

Commercial property investors should watch out

Another interesting side-effect is Tesco's impact on the commercial property market. As the FT notes, the decision to sell more non-food items online, and cut its store expansion programme, "will send shockwaves through the UK's commercial property sector."

Tesco has a huge influence on the sector: it accounted for more than 7% of British Land's annualised rent intake as reported in September, says the paper. Existing rents won't be affected of course. But anyone whose business relies on building new sites for supermarkets will be.

In the longer run, this could be good news for all supermarkets. An end to the 'supermarket space race', as Dave McCarthy of Evolution Securities calls it, would reduce spending and stop stores from cannibalising one another.

However, it's another good reason to be very picky if you are thinking of making commercial property investments in the UK.

So should you buy Tesco now?

The basic problem is this: Tesco has been shown to be fallible. Investors are now worried that Tesco is going to turn into Marks & Spencer a long slow slide from here, with no real prospect of recapturing the glory days.

My gut feeling is that I find it hard to believe that anyone who buys Tesco around this level will regret it in the long run. The share price slide has left it yielding around 4.5%, more than two times covered (see my colleague Tim Bennett's video on dividend cover for an explanation of this). I'll certainly be interested to see whether Warren Buffett decides to top up his stake over the next few months.

However, the supermarket faces a very tough year, and the share price could easily fall further. Profit warnings tend to come in threes, the saying goes, and there's a reason for that. Management has now publicly acknowledged that its strategy needs changing. But getting from where it is now, to where it wants to go, won't always be smooth running.

It'll take a while to get big investors in particular who now feel like fools for having stuck with what they thought was a relatively safe stock back onside and confident in management.

So if you want to take advantage of the profit warning to get exposure to the supermarket sector, there might be a better bet. While he doesn't mind Tesco, my colleague David Stevenson has long been a bigger fan of Sainsbury's (LSE: SBRY). Tesco's rival put out a far more cheerful trading statement earlier this week. You can read David's take on it here.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.