My, how things have changed at Tesco (LSE: TSCO)! This time a year ago I argued, in an article titled “Tesco PLC’s Property Time Bomb“, that the true “asset floor” for supporting the company’s share price was a lot lower than many investors imagined.
In November, after the release of the company’s half-year results, I followed up with an article titled “At What Price Would Tesco PLC Be A Bargain Buy?“, calculating the asset floor at 160p a share. A few weeks later, the shares made an intra-day low of 162.1p. I should probably have bought, given my 160p calculation was rough-and-ready, but that’s another story.
Since then, we’ve had Tesco’s annual results for the year ended 28 February 2015. Furthermore, new chief executive Dave Lewis, in his drive for increased transparency, provided “enhanced disclosure”, enabling my full-year calculations to be more precise than my rough-and-ready sums at the half-year stage.
The table below shows my calculations from November (based on the half-year accounts) and my calculations today (based on the full-year accounts):
| November 2014 (£bn) | Today (£bn) | |
| Net assets | 13.5 | 7.071 |
| Difference between market and book value of property | c. 13 | 3.600 |
| Goodwill & other intangible assets | (4.0) | (3.771) |
| Discounted operating lease commitments | c. (9.5) | (9.353) |
| Tangible net assets (tangible shareholders’ equity) | c. 13 | (2.453) |
| Per share value | c. 160p | (30p) |
What a difference! Let’s walk through what has changed in a few short months.
The starting point for my calculation — net assets — has fallen from £13.5bn to £7.071bn. This is explained partly by a fall in the value of assets (mainly property impairment), and partly by a rise in liabilities (mainly borrowings and the company’s pension deficit).
Goodwill & other intangible assets are little changed at around the £4bn mark. Discounted operating lease commitments are also little changed. This is “off-balance-sheet” debt, which arises from Tesco’s heavy selling of freehold property over the last 10 years at the cost of rising future rent bills. My November £9.5bn estimate for the discounted, or present value of this future debt is close to the £9.353bn figure Mr Lewis kindly provided us with under his enhanced disclosure in the full-year results.
The big change below the top line net assets is in the difference between the market and book value of property — a negative swing of £9.4bn. Tesco has slashed the market value of its property. Combined with the fall in net assets, this has led to my tangible shareholders’ equity figure of £13bn (or 160p a share) at the half-year stage, plunging to negative equity of £2.453bn (or minus 30p a share).
Meanwhile, Tesco has headline net debt of £8.5bn, which doesn’t seem too worrying against the company’s market capitalisation of £17bn. However, the true balance sheet leverage is £21.7bn, including the discounted lease commitments and pension liability.
Don’t let anyone tell you Tesco has a strong balance sheet! The below-the-surface weaknesses are why credit ratings agencies have downgraded the company’s corporate bonds from ‘investment grade’ to ‘junk‘, and why Mr Lewis, as soon as he arrived CEO’s chair, identified “protecting and strengthening the balance sheet” as one of his top priorities.
Tesco produced £1.5bn of operating cash flow last year, and Mr Lewis has bemoaned the company’s running £1.4bn a year rent bill. On top of that there are debt repayments in excess of £1bn to be made in both 2016 and 2017, and annual £0.3bn pension deficit payments. Tesco isn’t facing an immediate cash crunch — it has an undrawn £2.6bn revolving credit facility and £2.2bn of other undrawn committed facilities — but it does need to strengthen its balance sheet and start generating more cash.
Credit rating agency Moody’s has said recently that Tesco needs to raise in excess of £5bn to alleviate the stress on its balance sheet and return to an investment grade rating. Tesco put its data analytics business Dunnhumby (which manages Clubcard) up for sale earlier this year. There’s been plenty of talk but no takers yet for an operation that is said to be valued at £1bn-£2bn by potential bidders. Rumours are also rife that Tesco is on the verge of selling its South Korean business, with a figure of £4bn being bandied about.
One would hope that Tesco’s troubles are bottoming out and that the company can get back on to a firm footing. However, I don’t see hope alone as sufficient reason to buy at the current share price of 210p.
