Why I’m Buying More Tesco PLC For The First Time In Two Years

I first started buying Tesco’s (LSE: TSCO) shares back in 2012, when the first signs that the retailer was struggling emerged. My thesis at the time was that Tesco, as the UK’s largest retailer, had the size, market share and diversification needed to out manoeuvre peers. 

However, when it became apparent that the UK retail market was undergoing an enormous structural change, I stopped buying and started waiting for Tesco’s management to put forward a coherent strategy to take on the discounters. 

Unfortunately, over the past three years Tesco’s situation has gone from bad to worse.

Luckily, my Tesco holding is only a small part of my portfolio and I’ve been waiting for signs of a recovery to emerge before averaging down.

Green shoots 

Over the past few months, figures have started to suggest that Tesco’s recovery is under way. 

Indeed, Tesco’s first-half report was full of positive figures. For example, the volume of goods sold at Tesco’s stores rose 1.4% during the period, and the number of transactions rose 1.5% as Tesco started to win back customers. Further, in the six months to August 29, Tesco generated free cash flow of £281m, compared with a £134m outflow in the year-earlier period. Many City analysts weren’t expecting Tesco to generate any cash at all. 

Sales at the company’s European operations also showed improvement and Tesco Bank continued to be an invaluable source of income for the group. 

Charting a course

Tesco’s troubles are similar to those faced by larger peer Carrefour several years ago, and by using Carrefour as a case study, it’s possible to try and predict how long it will take Tesco to stage a full recovery. 

Carrefour, the world’s second largest retailer in terms of sales, ran into trouble back during the financial crisis. The European debt crisis sent the retailer over the edge and during 2011 the company’s share price was cut in half. Sales collapsed across Europe and the company was forced to take drastic action.

Just like Tesco, Carrefour’s first move was to give its CEO the boot. The new CEO found a company that had become complacent, over-complicated and disconnected from its customers and its roots — sound familiar?

So, during 2012 the turnaround began. The new CEO immediately slashed the hefty marketing budget and began exiting markets around the world. Then dividend payout was scrapped and what has been described as a ‘ruthless’ cost-cutting programme began.

Carrefour reported a loss of €1.8bn for 2011, but last year profits had risen to €1.3bn. It has taken more than two years for Carrefour’s recovery to take shape but Tesco’s recovery shouldn’t take as long.

The company is not restricted by draconian labour laws so costs can be cut faster, and unlike Carrefour, which has had to struggle with high unemployment low economic growth across Europe, Tesco’s home market is one of the fastest-growing developed economies the world.  

Skin in the game 

Overall, there some signs that Tesco’s recovery is taking place, but based on Carrefour’s recovery, Tesco has 12 to 24 months of work to do before it can claim to be back on the path to growth. 

Nevertheless, Tesco’s management seem to have a positive view of the company’s prospects. At the beginning of this month, six of the company’s directors spent £550k buying shares in the troubled retailer. 

Still, this is just a rough appraisal of Tesco's prospects. Before making a trading decision, you should conduct your own research to see if the company in question is suitable for your portfolio and financial goals. 

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Rupert Hargreaves owns shares of Tesco. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.