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Tesco PLC Cuts Its Dividend By 75%, Yet NOW Is The Time To Buy!

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Here at the Fool, we’ve been warning that Tesco’s (LSE: TSCO) (NASDAQOTH: TSCDY.US) dividend yield of 6% was vulnerable, and now it has gone.

I never expected the cut to be as savage as 75%. Tesco’s first-half dividend will be just 1.16p per share, down from the 4.63p paid in the same period last year.

Clearly, drastic action was called for, with new figures showing trading profits would fall by as much as 27% this year. That’s the second profit warning in the last two months.

Perversely, today’s news could also be the best thing that has happened to Tesco in some time.

Dividend Disaster

2014 has been an annus horribilis for Tesco. Its share price has dropped from 330p to 235p since January, a fall of nearly 30%.

Earlier this week, we warned that Tesco’s shares could only be worth 200p. Today’s dividend destruction makes that more likely. Tesco is already down around 7% on the day. Understandably so, given that its whopping dividend (deceased) was the single most alluring item in its shop window.

But this also be the spur for radical action at Tesco badly needs.

Action This Day

The action has started. New boss Dave Lewis will now start on Monday, one month earlier than originally planned. You can’t waste time when you’ve got the UK’s number one retailer (ailing) to save.

His job is to review all aspects of the group “to improve its competitive position and deliver attractive, sustainable returns for shareholders”. He has a battle on his hands.

Shoppers fell out of love with Tesco some time ago, but kept going there anyway, because they thought it was cheap. Then they discovered Aldi and Lidl.

This Means War

It will be interesting to see whether former chief executive Philip Clarke’s goal of making Tesco stores a ‘destination’ by adding family restaurants and artisan bakeries will survive. In today’s cut-throat, cut-price grocery sector, his strategy looks fanciful.

No prizes for guessing what most of the dividend money will surely be spent on. Investors have little to gain from a supermarket price war, but they’ll get one anyway.

My worry is that shoppers are in a churlish mood, and Tesco will struggle to match the German discounters of price and pulling power. That said, the Morrisons price war did pay off, delivering a 2.4% rise in sales over the last month, and a modest share price increase as well.

Maybe Tesco can repeat the trick.

Capex Cut

Lewis needs to do a lot more than that. He needs to refresh the brand, improve staff attitudes, and recapture customer goodwill.

That won’t be easy given today’s challenging conditions (will wages at the bottom ever rise?), and a £400m cut in Tesco’s planned capital expenditure to £2.1bn.

Worryingly, spending cuts will be focused on two areas which could drive sales: IT, needed to develop its successful online sales channel, and its store refresh programme, which now faces a slower roll-out.

Tesco Could Turn It around

It is always darkest before the dawn, but at least senior management has grasped the fact it is in a dogfight, and is baring its teeth (even if shareholders are the first victim).

As the UK’s largest supermarket, Tesco has plenty of firepower, especially with the dividend saving. It retains the power to spring surprises, such as last year’s successful budget-priced hudl tablet.

Tesco also boasts an impressive 45% share of the fast-growing online grocery market, far larger than its 28.8% share of the overall beleaguered grocery market. Its Metro and Express stores are successful (if often just as scruffy and unkempt as the cornershops they’re competing with). Click & Collect has proved a hit.

Best of all, you’ll be buying in the certainty that the dividend will be pathetic. Yes, that’s terrible news, but it does mean that you are getting the share 7% cheaper than yesterday.

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Harvey Jones 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.