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Is Tesco PLC’s Recovery Plan A Buy Signal?

Those buying Tesco (LSE: TSCO) shares in December and catching the low of about 165p saw a nice gain when the shares rallied on Thursday 8 January’s trading update hitting the wires.

Recent share price movements make the chart look like the trend reversed from down to up, but if I’d been lucky enough to catch that bounce I’d be selling now and moving on.

Solvency threat

You know things are grim when a firm cancels its dividend completely, and that’s exactly what Tesco just did with its final payout for the current financial year.

The dividend-decision summarises the directors’ view of the strength of a business and its future prospects. Cutting a dividend is a big deal because of the message its sends out — directors of big stock market listed companies don’t take that decision without heavy duty consideration.

Yet cutting the dividend is essential. Tesco’s balance sheet, and therefore its very solvency, is under threat. Other measures announced that are designed to protect the firm’s financial position include a significant revision of the store building programme and a £1billion reduction in the capital expenditure budget. Make no mistake about it, growth is off the agenda; what we see with Tesco today is a vicious fight for survival.

A shrinking business

Back in October, I said recovery at Tesco seemed likely to involve asset shedding and contraction, and that such measures could affect Tesco’s earning potential.

That’s starting to happen in the firm’s UK business. Thursday’s update revealed plans to close its head office and 43 unprofitable stores, which is good news in terms of cost cutting, but bad news for those hoping for a recovery in business that might have turned those locations into profit centres. The firm also plans to dispose of Tesco Broadband and Blinkbox to TalkTalk.

Tesco announces other cost-cutting measures, too, but CEO Dave Lewis and his team have a monumental task ahead to turn Tesco around in the face of changing and deteriorating market conditions. Discounting competition from the likes of Lidl and Aldi whips up a strong and gathering head wind. The only effective counter I can see in the recent update from Tesco is cost cutting, down pricing and growth-abandonment. A race to be the cheapest — competing on price — rarely enriches anyone.

Where next?

Tesco may stabilise its margins with these fire-fighting measures, but a low-margin, high-volume business model is perhaps the worst kind of candidate for a turnaround investment.

Maybe the recent share-price buoyancy is as good as it will get for Tesco shareholders. With the safety net of the dividend now snatched away, investing in Tesco looks risky to me. The firm reckons the immediate priority for proceeds from its new level of financial discipline and cost control will be reinvestment in its core customer proposition. However, profit stabilisation seems more likely than profit growth over the medium to longer term in my eyes, so where will the impetus for a share price upsurge come from here?

The recent share price uplift seems more like a sell signal than a buy signal, to me!

I'm avoiding Tesco and the supermarket sector in favour of stronger investment propositions elsewhere. These five shares make good candidates for further research and remain strong and well placed in their sectors.

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Kevin Godbold 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.