Why Tesco PLC Is Down 50% This Year

Is Tesco PLC (LON:TSCO) down and out, or is the UK’s largest supermarket a classic recovery investment?

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Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) shares are down by almost 50% this year.

Unfortunately, this descent has been matched by Tesco’s earnings per share, which fell by 47% during the first half of this year, compared to the same period last year.

A grim year

Tesco’s like-for-like UK sales fell by 4.8% during the first half of the year, and the group recently issued its fourth profit warning in 12 months, cutting its guidance for full-year trading profit (adjusted operating profit) to just £1.4bn, £500m lower than previous guidance of £1.9m.

The appointment of new chief executive Dave Lewis also triggered the discovery that Tesco had overstated its first-half profit guidance by £263m, triggering an investigation by the Serious Fraud Office.

As a result of the management clear-out that followed this scandal, Mr Lewis is currently running the firm’s UK business himself, while Tesco searches for an external hire to run its UK operations.

I suppose cash is tight?

Tesco’s net gearing is now an uncomfortably high 66%, and most City analysts believe that Tesco will either have to hold a rights issue or sell off some of its overseas assets in 2015, in order to strengthen its balance sheet.

We’ll find out more on January 8, when Mr Lewis has promised to unveil his recovery plan alongside the firm’s traditional post-Christmas trading update, which should be interesting.

Will there be more bad news?

I suspect there will be one more round of bad news in the New Year.

The final dividend could be cancelled, and I think Tesco is likely to declare a large, non-cash impairment on its property portfolio, to reflect the reduced value of undeveloped sites.

Buy, sell or hold?

Let’s put Tesco’s situation in context: Tesco has a 30% share of the UK grocery market and is the UK’s largest supermarket. Global sales are expected to total about £61bn this year, on which it will make a profit of around £1bn.

This isn’t the end of Tesco. Although supermarket profit margins are undoubtedly falling, I believe that there is an attractive business within Tesco’s UK operations, especially as the firm is one of the leaders in the fast-growing convenience and home delivery markets.

Tesco now trades on around 13 times 2015/16 forecast earnings, which isn’t cheap. A further dip is possible, but I think we’re near the bottom, and rate the shares as a long-term buy.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares in 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.

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