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Tesco PLC: “At Least It Can’t Get Any Worse”

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Tesco (LSE: TSCO) has made so many mistakes over the past year that’s almost impossible to trust the company right now.

But after making so many mistakes, one set of analysts has taken the view that it can’t possibly get any worse for the struggling retailer. For example, according to analysts at Bernstein:

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“We can’t see much that the management can do wrong in the next few years that would make the shares worth less than today’s share price,” 

And it’s easy to agree with this view. The bad news has come all at once for Tesco over the past three or four months, compounding declines and not giving investors much time to digest the information before another piece of bad news emerges. 

What’s more, the recent landslide of bad news has actually given Tesco’s new management the excuse they needed to execute an aggressive cost-cutting and restructuring programme.

Unlocking value

With a licence to act however they see fit, Tesco’s new CEO Dave Lewis and his management team can carve up the Tesco empire to unlock value for investors and fund the group’s turnaround.

It seems as if management has already started carving. At the beginning of this week there was some talk that Tesco had placed its Asian assets up for sale, a move that could unlock billions for the retailer. 

Asset sales like these will help steady Tesco’s financial position, which has been under scrutiny recently as the retailer’s debts have grown. It’s estimated that Tesco needs to raise £3bn over the next two years to maintain its investment-grade debt rating. Current estimates show that Tesco has around £6bn of businesses ripe for disposal, including its Asian assets and data analysis arm.

Pessimistic outlook 

Tesco is not the first giant international retailer to get into trouble. Indeed, Tesco’s troubles are similar to those faced by peer Carrefour several years ago as the company suffered from falling sales within France, the group’s home market. However, after several years, asset sales and a restructuring programme, Carrefour has recently returned to growth and company’s share price has doubled from its lows.

For some reason, the vast majority of analysts don’t believe that Tesco can execute the same kind of turnaround. For example, it’s widely believed that Tesco’s profitability will never recover as the company slashes prices to try and drive sales growth. Moreover, some analysts believe that the group’s core portfolio of UK stores will never report a profit. It seems as if these forecasts underestimate the company.

Using Carrefour as an example again, not only has the group managed to return to profit within its home market but the company’s profit margins have doubled as the turnaround has taken place — it’s reasonable to assume that Tesco’s margins could do the same. 

It’s up to you 

Tesco has the potential to stage a comeback but investing with the thesis of, “it can’t get much worse” is hardly a great way to manage your portfolio. Therefore, for investors who are still sitting on the sidelines, Tesco is not a buy just yet. 

That being said, for existing holders there’s no reason to turn your back on Tesco. One of Tesco’s most attractive qualities is the company’s dividend payout. While the company may have slashed this year’s payout, City analysts still expect the company to offer a yield of 2.8% next year. Reinvesting this payout will turbocharge your returns when Tesco’s recovery finally gets under way. 

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Rupert Hargreaves owns shares of Tesco. The Motley Fool UK owns shares of Tesco. 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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