Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) was the contrarian plat du jour following its profit warning two years ago. After the price crashed from 390p to 320p, snapping up the shares was like buying a Tesco Finest steak that had inadvertently been tagged with a Value-range label — or so the contrarian argument went.
I wasn’t convinced — for three main reasons:
- The contrarian view wasn’t so contrarian. Tesco was being tipped by every value investor under the sun, and only 16% of analysts rated the shares a sell. This wasn’t darkest-hour stuff. (A truly unloved share at the time was AstraZeneca, which 39% of analysts were advising dumping.)
- Historically, big supermarkets — like supertankers — take an age to turn round when they go off course. After a profit warning in 2004/5 it took J Sainsbury six years to get earnings back above their pre-profit warning level. It’s currently six years and counting for French supermarket giant Carrefour after a profit warning in 2008.
- It seemed to me that the fall in Tesco’s shares no more than reflected a new reality that included throwing £1bn at the UK stores to try to get the core business back on track, and management’s downward revision of its previous assumptions about the rate of long-term sustainable sales and earnings growth.
I wanted to see Tesco’s shares below 300p. Too greedy? I didn’t think so, given the risk of earnings getting worse before getting better, and history’s lesson of a likely protracted recovery.
Tesco’s shares are currently trading at around the 320p-330p level that eager contrarians snapped them up at on profit-warning day. Two years on, the share price may be the same, but earnings downgrades mean the forecast price-to-earnings (P/E) ratio is now around 10.5 compared with the 9 or so at which the early birds thought they were catching the worm.
I continue to have hopes of being able to buy Tesco’s shares at below 300p. The number of analysts rating the shares a sell has increased to 27% from 16% two years ago, and Tesco has been persistently managing-down market expectations for earnings, as reflected in the table of broker consensus forecasts below.
| Underlying diluted EPS (p) |
Forecast at November 2011 |
Forecast at November 2012 |
Forecast at November 2013 |
|---|---|---|---|
| 2011/12 | 37.15 | — | — |
| 2012/13 | 41.07 | 33.42 | — |
| 2013/14 | 44.58 | 35.35 | 30.99 |
| 2014/15 | — | 38.48 | 32.71 |
| 2015/16 | — | — | 34.68 |
Expectations are continuing to be eased down. In Tesco’s Christmas Trading update just last week, the company said it expects 2013/14 full-year trading profit to be “within the range of current expectations … £3,157m to £3,416m, with a mean of £3,330m”. Those numbers are actually a bit below the estimates that were gracing Tesco’s website just before the update was issued: range — £3,321m to £3,462m; mean — £3,386m.
I think if the 2013/14 results come in at the lower end of expectations, and there are downgrades to 2014/15 EPS forecasts, we could see Tesco’s shares on offer below 300p during the course of this year. Given the recent history of falling EPS forecasts, it doesn’t require a huge leap of imagination to see forecasts for 2014/15 coming down to 30p and the company trading on a P/E of 10 — ie, the shares at 300p.
