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Why Warren Buffett Sold Tesco PLC

There has been much debate recently about whether supermarkets are a good investment. The news that Warren Buffett has reduced his stake in Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) has just added to this debate. In this article, I try to work out why he has sold shares in Tesco.

Buffett bought Tesco because he thought that supermarkets are gaining market share from corner shops and the high street, plus Tesco is expanding in the rapidly growing retail sectors of emerging markets.

A fragmenting retail market

But the reality has been a whole lot harsher. In the UK, the big supermarket chains (Tesco, Asda, Sainsburys, Morrisons) have not only been competing fiercely against each other, but against both high and low-end rivals such as Aldi, Lidl and Waitrose. Whereas a decade ago it seemed the grocery market was being gobbled up by fewer and bigger players, it has now begun to fragment again. Because of this, Tesco is no longer growing in the UK. What about emerging markets? Well, growth here has also been lacklustre. Profits in both Europe and Asia have fallen.

So I think Buffett’s share sale signals some disappointment about Tesco’s growth. But bear in mind that he has retained most of his Tesco shares, which suggests cautious optimism. My view is that Tesco has already expanded a lot, and it is now experiencing growing pains. It is trying to reinvent and refresh its image, both in the UK and abroad. This takes time, patience and hard work.

A work in progress

I have been impressed with the work undertaken to refresh Tesco’s Value and Finest ranges, to introduce restaurant chains such as Harris & Hoole and Giraffe, and to redesign its stores. But I see this job of renewal very much as work in progress, and the improvements have not yet filtered through to the bottom line.

What’s more, supermarkets are evolving from businesses that earn the bulk of their profits through giant out-of-town hypermarkets, to retail businesses that own thousands of town-centre minimarts, as well as mid-sized supermarkets, hypermarkets, plus a myriad distribution centres for their rapidly growing internet sales. As internet sales grow and grow, there is also the potential of alliances with internet retailers. In this world of the long tail, one size fits all no longer works in retail.

Abroad, Tesco has the resources for a big push in markets such as China and India, where the retail market is rather like the States and Europe post-war: full of possibilities for growth. Tesco is taking the partnership approach to emerging market expansion, using and building on tried and trusted brands.

So, long term, I see Tesco consolidating in the UK, and resuming growth abroad. But, in one of the world’s most competitive businesses, its task is not easy. So I see why Buffett is cautious — Tesco’s share price in recent years has been disappointing. But I continue to hold.

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> Prabhat owns shares in Tesco and Morrisons, but in none of the other companies mentioned in this article. The Motley Fool owns shares in Tesco and has recommended shares in Morrisons.