It’s been an extremely disappointing three years for investors in Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US), with the UK’s biggest retailer seeing its share price fall by 30% while at the same time the FTSE 100 has risen by 14%. That’s a considerable amount of underperformance and it seemed as though ‘enough was enough’ this week when Chief Executive, Philip Clarke, stood down.
His replacement, Dave Lewis (a senior director at Unilever) will inherit a company with significant short-term problems, but with vast long-term potential to deliver profitability growth and add value for shareholders. Here’s why.
Strategy Is Key
Clearly, a company’s strategy is always crucial, but with Tesco it appears to have added importance at present. That’s because its strategy has been exceptionally poor in recent years and it needs to make wholesale changes in order to improve the top and bottom lines.
Indeed, Tesco has adopted a policy of cutting prices to such an extent that its margins have been slashed, with this strategy so far being unsuccessful in attracting core customers who have defected to discount retailers such as Aldi and Lidl. It has also lost higher end shoppers that were previously serviced by Tesco’s higher price point goods (such as its Finest range) as the company is now seen as little more than a slightly more expensive Aldi or Lidl, as a result of its obsession with price.
Tesco needs to copy its more successful competitors, such as J Sainsbury (LSE: SBRY) (NASDAQOTH: JSAIY.US). It has experienced disappointing figures in recent months, but prior to that had been weathering the challenging trading conditions of the UK supermarket surprisingly well. That’s because it remained competitive on price (via its price match coupon offer, for example), but still focused on emphasising the quality of its goods. This helped it to keep core customers and, ultimately, deliver better profit figures than Tesco.
With a change in strategy, Tesco can make a strong comeback. Certainly, the short term is likely to continue to be a challenging time for investors, but as a long term investment it remains highly attractive. For instance, it trades on a price to earnings (P/E) ratio of just 10.4 (versus 13.7 for the FTSE 100) and yields a very impressive 5.1%. This shows that Tesco has the potential for a significant upward rerating and that, in the meantime, it remains a great income play. Both of these attributes make it a sound long term investment that could make a positive contribution to your mortgage repayments.
Peter Stephens owns shares of Sainsbury (J) and Tesco. The Motley Fool owns shares of Tesco.