Is This The Straw That Breaks Tesco PLC’s Back?

Today’s profit warning from Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) is its third within the last three months and has caused the company’s share price to plunge by 10% at the time of writing.

While the market had been anticipating trading profit of over £2 billion for the full year, Tesco now says that it expects the figure to be no more than £1.4 billion. The major reasons for this are the fallout from the previous misstatement of profit forecasts, as well as new initiatives to try and boost sales in the medium to long term.

With the key Christmas trading period to come, is Tesco now a stock to be avoided? Or, is this the start of a comeback for the UK’s largest retailer?

A Transitional Period

Following the appointment of a new CEO, there are bound to be major changes at any company. In Tesco’s case, though, these changes are likely to be bigger and wider-reaching than for most businesses, since it is embroiled in an accounting scandal and is continuing to experience hugely challenging trading conditions. As a result, new CEO, Dave Lewis, is seemingly being ultra-conservative when it comes to the company’s accounting practices and is ensuring that no stone is left unturned regarding potential future issues.

As a result of this and an apparent shift in Tesco’s focus as a business, there are bound to be short-term costs. To be fair to Tesco, it did warn of such short-term challenges back in October and, looking ahead, there is likely to be more short-term pain before any kind of gain in terms of share price growth comes through.

For example, Tesco is trying to differentiate itself more clearly in terms of service and has hired 6,000 new members of customer-facing staff in recent months. This entails greater costs in the short term but, in the long run, this strategy could pay off – especially if disposable incomes increase in real terms and price becomes relatively less important to customers moving forward. In addition, Tesco is also continuing to invest in pricing in an attempt to maintain its market share. This policy also hurts short-term profitability, but could aid its longer-term growth profile.

Looking Ahead

While three profit warnings in as many months is hugely disappointing, it would be of little surprise for there to be more ahead. After all, there is little sign of any improvement in trading conditions and Tesco has a long way to go in terms of rationalising its business (non-core operations such as Blinkbox are reportedly up for sale and may cause write downs). As a result, there will inevitably be more lumps and bumps for investors in the company as we move through 2015.

However, with Tesco’s share price trading at such a low level, there does appear to be a significant amount of long-term value. Certainly, shares could fall further in the short run, but the market seems to be factoring in further disappointment (especially after today’s fall).

With shares in Tesco trading on a price to earnings (P/E) ratio of around 10.5, they seem to offer good value for money. As a result, and while there could be further disappointment ahead, it appears to be worth sticking with Tesco’s management team for the long haul, as they attempt to turn the company around.

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Peter Stephens owns shares of Tesco. 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.