Why I’m Still Bearish On Tesco plc

It will take more than an uptick in Tesco plc (LON: TSCO) sales to break a strong downtrend.

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Look at a share price chart of Tesco (LSE: TSCO) from the 1980s to today, and you’ll see a valuation that trends higher from year to year, reaching a peak around 2007, but which then falls lower and lower post-Credit Crunch.

Tesco is back to where it was 19 years ago

Tesco’s share price has now fallen to just 158p. It’s now back to where it was in 1997, some 19 years ago. This really is the rise and fall of Tesco, and it will take something fairly dramatic to break this trend.

Tesco bears will note, with a wry smile, that 1997 was the year that Sir Terry Leahy was appointed chief executive of the retail giant. And it was under his stewardship that Tesco expanded rapidly both in the UK and overseas. The Tesco of the 1990s employed far fewer people, in far fewer stores. Yet all those hard-earned share price gains seemed to have been wiped out.

Dig a little deeper and we can see why. What determines a company’s net value? Well, it’s not sales, nor turnover, nor number of people employed. A business’s share price is determined by its current and future earnings.

Tesco’s sales are far higher than they were 20 years ago — it is, quite simply, a far bigger company than it used to be. But, instead of profits growing with sales, they’ve actually fallen. This is because there’s much greater competition in the UK grocery market than there has ever been before. With increased pressure in the premium sector from Waitrose and Marks & Spencer, and also in the budget sector from Aldi and Lidl, Tesco is finding itself squeezed from both sides.

It’s still too early to buy back in

That’s why, although I very much welcome the recent uptick in sales from Britain’s leading retailer, I would like to see more evidence of a revival before I invest. What I, and every fund manager and city analyst, will be keeping an eye on is not sales, but earnings. If the increase in sales has been at the expense of profitability then I would remain bearish on Tesco. But if Dave Lewis has pulled the proverbial rabbit out of the hat and increased both profits and sales, then it would be time to buy back in – but I think this is unlikely.

I’m a regular shopper at Tesco, and I still think it offers the UK public the best combination of quality and value. But I’m less enamoured of Tesco’s charms as a potential investment.

In today’s low cost, China-centric world, competition in the British supermarket sector is fiercer than it has ever been. In a market where even heavyweights like Tesco are having to run to stand still, investors would do best to watch from the sidelines with interest, but stand well clear.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Prabhat Sakya has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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