300 Million More Reasons To Give Tesco PLC A Wide Berth

Today I am explaining why Tesco’s (LSE: TSCO) financial strength continues to sink.

Pensions peril adds to Tesco’s woes

Speaking to The Guardian newspaper at the weekend, independent pensions guru John Ralfe commented that Tesco is likely to have to pay £300m every year for the next 10 years in order to plug its gargantuan pensions shortfall.

According to the report, Tesco’s current pensions gap stood at around £3.2bn as of year concluding March 2014, a figure which the supermarket failed to address as in-house assessments into the size of the shortfall is not expected to conclude until May.

The retailer has until June to detail the size of the hole, as well as how it plans to solve the problem. Ralfe said that he expects the figure for fiscal 2015 to match that of the previous year, although of course any uptick could herald further pressure on the Cheshunt-based firm.

Is the balance sheet about to break?

Tesco has seen the balance sheet come under heavy fire during the past two years as consumers have flocked to its competitors in droves. Budget chains such as Aldi and Lidl have proved increasingly attractive to savvy shoppers in the post-recessionary landscape, while premium outlets such as Waitrose are also dragging more affluent buyers from Tesco’s doors.

On top of this, Tesco has also suffered a number of PR own goals during the past year — from the horsemeat scandal of early 2013 through to ongoing pressure over the squeeze they place on suppliers — which has made it even more unpalatable to much of its previously-loyal customer base.

Tesco’s October interims underlined this slide, with a 4.4% decline in group revenues during April-September driving trading profit an eye-watering 41% lower, to £937m. As a result Tesco saw net debt rise to a colossal £7.5bn as of the end of September, up from £7bn at the same point last year.

The business remains determined to pull back customers through a programme of significant price cuts across the store, although these measures seem destined to underwhelm as they still fail to match the prices offered by the discounters.

And this expensive scheme puts extra stress on Tesco’s already wafer-thin balance sheet. The business was forced to slash the interim dividend by 75%, and has also significantly curtailed capital expenditure, and group outlay collapsed by more than a fifth to around £1bn in the first half, as a result of severe financial strength.

Is a cash call on the cards?

And with rumours doing the rounds that Tesco could be forced into a humiliating rights issue sooner rather than later, in my opinion the fallen grocery giant is a perilous stock pick for both growth and income investors.

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Royston Wild 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.