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The Investment Case for Tesco PLC

Tesco

Amongst the UK’s supermarkets, Tesco (LSE: TSCO)(NASDAQOTH: TSCDY) has the dominant market share of around 30%, compared to the 17% each of next-largest Sainsbury and Asda. It’s the most innovative, leading the way with non-food sales, banking and other services. And it’s the only one to have branched out overseas.

Unfortunately for investors, these features have done nothing for the shares. Tesco’s stock has lost 10% over the past twelve months. Understanding the reasons for that is crucial to determining the investment case. Some of Tesco’s problems are industry-wide and some are of its own making.

Outflanked

Normally a dominant market position should give a company competitive advantages that it can exploit to generate wider margins and fatter profits. But the UK supermarket sector is mature, with the major players fighting over marginal market share on the basis of price and perceived value. They have all been outflanked by the encroachment of the hard-discounters Aldi and Lidl on one side, and the premium food offerings of Waitrose and Marks and Spencer on the other, at a time of significant consumer belt-tightening. Changes in the nature of the UK market, with the rise of convenience stores and increasing online sales, have confused the picture. 

By its own admission, Tesco management took its eye off the ball in the UK. It has spent the past year and £1bn seeking to make up lost ground, though its market share has not yet stabilised. It also failed to translate its UK skills abroad, with forays into the US and Japan notable failures that it has since retreated from. Overseas success remains patchy.

Recovery

How well Tesco recovers from its sluggish performance likely depends on:

  • UK economic growth. Recovery in consumer spending would help the sector, and perhaps strengthen its fight against the discounters. Above-average exposure to non-food sales should be a boon, with Tesco having the scale online and in bricks-and-mortar to compete effectively against the likes of Amazon and AO.com.
  • Tesco’s turnaround programme. This has shown little concrete signs of producing results as yet, but investment in stores and merchandising should eventually deliver.
  • Continued innovation. With its core business in a mature industry, Tesco must continue its heritage of finding new growth areas, whether by product or delivery channel or geography.

Meanwhile, investors receive a flat dividend which represents a 4.4% yield and looks reasonably safe. If management can pull off a turnaround, the shares will look like a bargain.

Resilient

Tesco may have had a torrid couple of years, but it is resilient. That quality is one of the reasons that the Motley Fool has picked it as one of "Five Shares to Retire On", all companies that have dominant market positions, healthy balance sheets and reliable cash flows.

To find out which the other four are, you can download an exclusive report by clicking here -- it's free.

Tony owns shares in Tesco and Sainsbury but no other shares mentioned in this article. The Motley Fool owns shares in Tesco.