Why The Market Is Wrong To Bet Against Tesco PLC’s Boss

The shares of Tesco PLC (LON:TSCO) are not expensive at this price, argues Alessandro Pasetti.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The bears are in town. Investors are betting on a decline in Tesco‘s (LSE: TSCO) stock price “as optimism around chief executive officer Dave Lewis’s revival plan has waned“, Bloomberg stated on Friday. 

Tesco short sellers are coming back in droves,” the news agency wrote, adding that “the number of bets taken out against the company’s share price has risen sevenfold since Tesco’s annual results in April.

In a short selling, investors borrow shares from a broker in order to sell them to someone else at the current price, betting that their value will fall fairly quickly. If that happens, they can buy the borrowed shares for lower than the price they sold them for, in order to fulfil the trade, thereby banking a profit.

This sort of trading carries big risks. If the price goes up you’ve got to buy the borrowed shares for more than you’ve been paid — and is likely to backfire with Tesco, in my view. 

Two Problems

The first problem is to determine whether the UK’s largest grocer will be able to hit a 2016 underlying trading profit higher than £1.3bn–£1.4bn, hoping that Tesco will meet estimates of £1.6bn and £1.8bn in 2017 and 2018, respectively.

Investors also have to make sure that based on the value of its assets Tesco is a reasonable value play. 

Trading Profit

Say that Tesco’s sales decline 2% to £61bn in the current year (fiscal 2016) — a drop in line with that of fiscal 2015. Both its quarterly performance — at constant rates, excluding fuel and VAT — and market share data suggest that such a performance is pretty likely. I’d not expect Tesco to surprise investors on this front. 

Its 2015 trading profit was down 58% to £1.39bn year-on-year, with the UK — the biggest revenue contributor at £43bn, excluding VAT — generating some £467m. Previously a cash cow, the UK operations have become a money pit. 

Its domestic trading margin came in at 1.07% in 2015, a reduction of almost four percentage points year-on-year: the impact of like-for-like sales decline was clearly felt, but the combination of “prior initiatives” and “net cost base inflation” had a bigger impact on Tesco’s poor performance, which read -79% over the previous year in terms of trading profit.

Prior initiatives, in particular, were a drag on performance, and a much bigger issue than much-publicised investment in lower retail prices. 

Quite simply, once “prior initiatives” in the UK are deducted — and there’s reason to believe they will go down over time — the “New Tesco” led by Mr Lewis may be able to record a trading profit margin of between 2.5% and 3%, yielding a trading profit of between £1.5bn and £1.8bn. There are risks associated with these estimates, but Tesco could indeed hit its medium-term goals sooner than expected. 

You should also consider that its Asian operations reported £9.8bn of sales and a trading profit of £565m (down 18%, trading margin at 5.7%), while Europe’s £8.5bn of revenues contributed £164m (down 31%, trading margin at 1.93%) to the group’s underlying trading performance.

Management is playing down expectations, of course, but a target of at least £1.5bn for a 2016 trading income is doable, I’d argue. 


Some £5bn of undrawn credit lines cover for the majority of its net debt position, while the duration of its debt profile offers some reassurance, although net leverage is high. 

So, let’s move on to the value of its current and long-term assets. 

Taking into account the book value of:

  • inventories, £2.9bn (as at 28 February)
  • trade and receivables, £2.1bn
  • loans and advances to customers, £3.8bn
  • Cash and equivalents, £2.1bn
  • other current assets, £650m

you’d be buying Tesco’s equity at 213p a share against £11.5bn of cash-like items, whose value is 141p a share.

Yet there are still some £30bn of long-term assets that must be taken into account.

If we apply to these non-current assets a massive discount of about 80%, thus betting on huge write-downs over time, we’d still have to add £6bn (about 74p a share) to a valuation of 141p a share for Tesco’s current assets.

Then, Tesco’s equity would be valued at £17.5bn, which is bang in line with its current market cap, but does not include the difference between the book value of its total long-term assets and the aggregate value of net debt, discounted operating lease commitments and pension deficit. 

That’s about 37p a share, or £3bn in terms of additional market cap. 

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.

Alessandro Pasetti has no position in any shares mentioned. 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.

More on Investing Articles

Businessman use electronic pen writing rising colorful graph from 2023 to 2024 year of business planning and stock investment growth concept.
Investing Articles

Buying 8,617 Legal & General shares would give me a stunning income of £1,840 a year

Legal & General shares offer one of the highest dividend yields on the entire FTSE 100. Harvey Jones wants to…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

£25k to invest? Here’s how I’d try to turn that into a second income of £12,578 a year!

If Harvey Jones had a lump sum to invest today he'd go flat out buying top FTSE 100 second income…

Read more »

Union Jack flag in a castle shaped sandcastle on a beautiful beach in brilliant sunshine
Investing Articles

2 lesser-known dividend stocks to consider this summer

Summer is here and global markets could be heading for a period of subdued trading. But our writer thinks there…

Read more »

pensive bearded business man sitting on chair looking out of the window
Investing Articles

Here’s how I’d aim to build a £50K SIPP into a £250K retirement fund

Our writer outlines the approach he would take to try and increase the value of his SIPP multiple times in…

Read more »

Investing Articles

9.4%+ yields! 3 proven FTSE 100 dividend payers I’d buy for my Stocks and Shares ISA

Our writer highlights a trio of FTSE 100 shares with yields close to 10%. He'd happily pop them into his…

Read more »

Mixed-race female couple enjoying themselves on a walk
Investing Articles

Are Raspberry Pi shares a once-in-a-lifetime chance to get rich?

With Raspberry Pi shares surging after a successful IPO, could this UK tech startup offer a long-term wealth creation opportunity…

Read more »

Newspaper and direction sign with investment options
Investing Articles

Huge gains and 9% yields: why now’s an amazing time to be a stock market investor

The stock market’s generating fantastic returns in 2024. Whether you're looking for gains or income, it’s a great time to…

Read more »

Hand of person putting wood cube block with word VALUE on wooden table
Investing Articles

This steady dividend payer looks like one of the best bargain stocks in the FTSE 100

A yield of 4.7% and a consistent dividend record make this FTSE 100 company look like good value in an…

Read more »