Tesco Plc And TalkTalk Telecom Group Plc: Avoid Catching The Falling Knife

Investors who have seen shares of TalkTalk Telecom Group Plc (LSE:TALK) fall by 29% over the past year may be tempted to chalk it all up to October’s hacking scandal and decide now is the time to buy shares at an attractive discount. However, there were problems even before the scandal broke – namely the latest half-year report that saw the company register a £7m loss compared to a £15m post-tax profit for the same period in 2014, despite a steady 4.7% rise in revenue.  

TalkTalk management is still relying on a strong second half to make up for these disappointing numbers, but it seems very unlikely that the anticipated £35m losses related to the hacking scandal will allow them to reach their goals. By coming out and saying full-year forecasts can still be met, management may well be setting themselves up for a sell-off come the next quarterly trading updates.

There are bright spots for the business, though. The hack ended up being far less severe than first expected, with only 4% of customer’s financial data being stolen and that data being unusable to criminals. The 15% dividend increase in November also means the shares now offer a 6.7% yield. The attractive yield and stability of the business model do make TalkTalk an intriguing option. Despite this, I would be leery about diving in just yet. Upcoming trading updates will provide a glimpse into whether management is able to continue driving growth after the massive hit to the company’s reputation and turn around declining margins.

The pain continues…

The five year slump for Tesco Plc (LSE:TSCO) continued in 2015 with share prices down another 23%. Furthermore, the latest Kantar Worldpanel data released in December have done nothing to suggest the share price will be rebounding anytime soon. These numbers saw Tesco sales slump 3% year-on-year while Lidl’s jumped 17.9% and Aldi’s 15.4%. Tesco CEO David Lewis should also worry about the pain Asda is feeling. Asda’s parent, Walmart, should it decide to step in and do whatever it takes to regain market share, could pile even more pain on Tesco’s already withering margins.

Lewis is doing an admirable job staunching the bleed by selling-off Tesco’s Korean assets and applying the windfall to pay off £4.2bn of debt, closing 53 unprofitable stores through the end of September 2015, and switching the company from a defined benefit pension to a defined contribution scheme. These moves mean that with some £5bn in cash and undrawn lines of credit the company should have some breathing room to reorganise and plot a return to growth despite being in debt to the tune of £18bn.

Unfortunately, I don’t see the catalyst that will vault Tesco shares back to the lofty prices they commanded in the pre-recession halcyon days. As low-cost competitors cut into margins and the company continues to offload assets to pay its debts, long-term investors would be much better served by investing their capital in other companies.

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Ian Pierce has no position in any shares mentioned. 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.