8.2 Reasons Why Tesco PLC Is A Risky Retail Pick

In this article I am looking at why I believe an increasingly-competitive grocery market should continue to whack Tesco’s (LSE: TSCO) earnings prospects.

Rise of the retailers crimps turnover

Tesco’s ambitious turnaround strategy, introduced in the wake of its shocking profit warning in early 2012, continues to flail badly. The company has been unable to effectively address a backdrop of rising competition in its home markets, and latest Kantar Worldpanel data showed the collective market share of Britain’s top two budgeteers — Aldi and Lidl — surge to 8.2% during the 12 weeks to 27 April, a beastly omen for the likes of Tesco.

The figure shows a meaty improvement from the 7.5% combined share recorded in the corresponding 2013 period, confirming the stellar momentum the businesses are showcasing. While Aldi reported mammoth year-on-year sales growth of 36.1% during the 12 weeks, Lidl saw checkout activity leap 20.9%.

By comparison, Tesco saw sales slip 2.4% during the period, pushing its own share of the supermarket space to 28.7% from 30% last Tescoyear.

Tesco, along with mid-tier grocery rivals Sainsbury’s and Morrisons, continue to dole out fresh waves of discounting in order to compete with its cash-conscious rivals. But at the moment these measures simply appear to be eating away at margins, and Tesco saw trading profit margins droop 34 basis points lower last year to 5.17%.

And Tesco should be gravely concerned by its low-cost rivals’ ambitious expansion strategies. Indeed, Aldi announced in recent days plans to build 55 new stores this year alone, up from around 500 currently and to extend a further 30 existing sites. And further afield, discount general merchandise chain B&M confirmed last week its intention to press ahead with an initial public offering to bolster its own expansion drive.

City analysts expect Tesco to post a third successive annual earnings decline in 2014, with a 14% drop currently pencilled in. A modest 2% rebound is anticipated for the following 12-month period, figures which create P/E multiples of 11.3 and 11.2 for this year and next, trending above the value benchmark of 10 times predicted earnings or below.

Tesco’s continues to invest colossal sums in the white-hot growth areas of online and convenience store shopping, but at the moment these channels currently represent a modest percentage of group turnover. While Aldi et al continue to nibble away at the bottom of the market, and Waitrose and Marks & Spencer strip away Tesco’s more affluent customer base, I believe that the Cheshunt-based firm could be in for prolonged trouble at the tills.

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Royston does not own shares in any of the companies mentioned in this article. The Motley Fool owns shares in Tesco and has recommended shares in Morrisons.