Warren Buffett has just raised his stake in Tesco.
Last Monday Warren Buffett's Berkshire Hathaway (NYSE: BRK-B.US) announced that it would be buying back its shares in the open market.
Berkshire has never bought back its shares because Buffett has always maintained that the company can more usefully deploy its capital elsewhere. This has attracted a lot of attention since Buffett is basically telling us that he believes that his company's shares are cheap.
One consequence of this was that another piece of Berkshire-related news which appeared on the same day, that Buffett had added to Berkshire's 3.21% holding in Tesco (LSE: TSCO) by buying a further 34 million shares, has received very little coverage in comparison.
Tesco shareholders should be heartened by this as it represents a big vote of confidence in Britain's number one supermarket chain and bodes well for its future.
All about moats
Buffett likes to own shares in businesses which possess what he calls a "moat"; a competitive advantage like a good brand name and/or economies of scale which protects it from competition. Tesco's moat comes from its being the biggest supermarket chain in the UK which gives it tremendous economies of scale, in particular increasing its bargaining power when it comes to cutting deals with its suppliers.
Tesco is further helped by the British food retailing market having developed into an oligopoly where over three-quarters of the market being in the hands of Tesco and three other firms, Morrison (LSE: MRW), Sainsbury (LSE: SBRY) and Wal-Mart's (NYSE: WMT.US) subsidiary ASDA. This makes it extremely difficult for a competitor to break into the British food retail market and is why the Competition Commission regularly launches probes into the industry.
Show me the money
Tesco shares are up by about 4% since the announcement and, as I type this, they're trading at 379p where they sit on a historic price-earnings (P/E) ratio of 10.6 and yield just over 3.8%.
It's no surprise to me that Buffett is building up his stake in Tesco. He's been adding to Berkshire's overseas investments in the last few years, in part because of concerns over the long-term value of the dollar, and Tesco clearly meets his criteria for a long-term investment.
What buyback?
The last time Buffett made an offer like this was in the 1999 annual report, where he offered $45,000 per "A share." Berkshire's share price rocketed shortly afterwards and no-one took advantage of it by selling their shares at below the market price!
The price that Berkshire will pay has been capped at 110% of Berkshire's net asset value (NAV). In the most recent quarterly report (30 June), the NAV was just under $ 99,000, so buybacks will only take place when the A's are trading at around $109,000, though Buffett will be using a more up-to-date NAV. Since the A's are currently trading at $108,020, it seems fairly likely that Berkshire will buy back some of its shares.
By making this statement, Buffett has effectively put a floor under Berkshire's share price because this implies that he believes that the shares are undervalued (otherwise he wouldn't be buying them). Hopefully for Tesco's existing shareholders Buffett's added interest in their company will send out a similar signal.
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> Tony owns shares in Berkshire Hathaway. The Motley Fool owns shares in Tesco.
