Three reasons to short Tesco

published 8 December 2011

Tesco, the world's number three retailer, is having an unusually torrid time British sales fell for the fourth quarter in a row recently. Here are three reasons why spread betters can assume this pain will continue for now.

First off, Tesco is not just exposed to the food market. It also sells big-ticket items of the sort that consumers are cutting back on most heavily. While food staples are essential items, clothes and electrical goods are not. That's in part why Tesco is suffering more than, say, Morrisons or J Sainsbury's on the sales front. Worryingly, even a massive £500m price cutting promotion ahead of the crucial Christmas season has not injected any extra oomph into the numbers.

Sure, the international business is still going strong (sales up 8.2% on the latest numbers) but that can't yet compensate for the fact that the UK still accounts for two-thirds of Tesco's sales, and three-quarters of its profits. With the threat from much cheaper retailers such as Aldi and Lidl growing all the time, Tesco cannot afford to get caught in the middle, offering what one commentator calls "Waitrose-level prices and Asda-level service".

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Next up, a classic red flag for any business high senior management turnover. It was always going to be bad news for the brand when its leader Sir Terry Leahy retired. Since then, both former finance director, Andy Higginson, and David Reid, the non-executive chairman, have said they will resign. The head of the US Fresh & Easy unit, Simon Unwins, has also left. Now, the latest big name to announce his resignation is David Potts, the head of Tesco's Asia operations. In short, when a name as big as Sir Terry leaves a firm, others always follow soon afterwards. In operational terms, this is never good news in the short term. Even assuming no other big name departures, it will be months before recent changes are properly bedded down.

The last reason to be wary of Tesco right now is Warren Buffett. The US investor has held shares in the group since 2007 and says he plans to increase his stake. That sounds bullish until you look at what he told CNBC recently: "if the price came down on Tesco, I'd buy some more of that". So Buffett wants in again, but not necessarily at current levels even on a price / earnings ratio of a modest ten. The big US investor often gets what he wants. So look out for a share price drop. The full horror of what looks like being a dire Christmas shopping season might just be the trigger.

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.