COMMENT
Tesco's American Dream

By Ed Bowsher (TMFArkle)
February 14, 2006

I wrote an article last November in which I said that Tesco (LSE: TSCO) should resist the temptation to enter the US market. Well, Tesco's directors didn't agree! Last week the company announced plans to create a new convenience store chain on the US west coast. The chain will be similar to the UK's Tesco Express format.

If Tesco must enter the US, this is probably the best approach. Crucially, it means that Tesco won't be competing head on with Wal-Mart (NYSE: WMT). That's because Wal-Mart doesn't have a big presence in convenience stores and is also relatively weak in California.

It's also good news that Tesco isn't buying an existing chain. There had been rumours that Tesco might buy Albertsons (NYSE: ABS) or Meijer, a privately owned business. Steering clear of takeovers means there's no danger that Tesco might over-pay.

So why do I think the move is a mistake?

I'm not saying that the US move will definitely fail. But I do think it's a risky move. So many UK retailers have failed in the US; there's a decent chance that Tesco will do no better.

I'm also concerned that it's a distraction for management. Tesco has already lost several senior managers in the last few months, and now a main board director, Tim Mason, will work full-time in the US. Tesco needs to keep top managers in the UK so it can be sure that its strong market position won't be eroded.

There is also plenty of work to be done in Asia and Central Europe. The last interim numbers showed that the operating margin for Tesco's emerging markets business was only 3.8%, compared to 6% in the UK. What's more, international like for like sales only grew 4.4%. That was a disappointing figure given that Tesco's overseas stores operate in fast growing economies.

Don't get me wrong, I'm excited by the potential of the emerging markets businesses. I just think that Tesco needs to concentrate on these markets to ensure eventual success.

That said, I still think that Tesco is an attractive share despite its US plans. The company trades on a price/earnings ratio of 16, which is reasonable given the company's track record in the UK and the emerging markets potential. I've also read reports that Tesco might do a modest deal to release some of the value in its property portfolio which would be a welcome bonus.

However, the US move means Tesco is not quite as attractive as it was two weeks ago.

Are you looking for companies that have an international reach like Tesco? Champion Shares has recommended a truly global company with operations in Japan, the US and across Europe. Sign up now for a FREE 30-day trial and you can read our full recommendation. Annual subscribers will also receive a free book, Richard Farleigh's Taming the Lion (RRP £12.99).