Shares of Tesco (LSE: TSCO) are up 35% from January lows, suggesting many in the City are finally predicting a turnaround for the struggling grocer. The enthusiasm stems from market share decreases slowing to their lowest pace in years and better-than-expected Christmas numbers.
Flat sales are certainly better than declining sales, but Tesco still faces the gale force headwinds it’s been grappling with for several years now. Competition from low-cost chains and online-only rivals such as Ocado and now Amazon have whittled away once stellar 5%-plus margins to a miniscule 0.77% for the past half year.
Increased competition won’t be disappearing overnight, which will constrain margins to well below their previous highs. With falling margins, £18bn in debt and stagnant market share, this rally is looking unsustainable to me. And, with shares trading at an eye-watering 41 times forward earnings, Tesco is no bargain either.
Year to date, African gold miner Acacia Mining (LSE: ACA) shares have bumped up 46% in value, outpacing a 13% rise in gold prices over the same period. This rally came despite disappointing full year 2015 results showing a $124m annual loss. Furthermore, the company failed to meet its own target of generating free cash flow for the year and its production costs remain as high as they were in 2011.
This lack of progress on business fundamentals leads me to view the rally as essentially a bet by traders on gold prices continuing to increase over the coming quarters. While this could pan out, it would be risky indeed to buy a share based solely on a bet that gold will increase in value. Gold miners’ shares have never performed as well as the mineral itself, and Acacia’s stubbornly high costs and reliance on gold price movements to boost profits don’t inspire me with confidence that the company will challenge this narrative.
Embattled miner Glencore (LSE: GLEN) has surprised many by growing share prices a full 62% year-to-date. While much of this increase can be chalked up to a recent rally in commodities prices, the company itself has taken dramatic steps to right the ship.
Debt, debt, debt
Like many miners, Glencore piled on debt during the boom years of the Commodity Supercycle. By the second quarter of 2015, when prices for everything from copper to zinc were plummeting, the company had a full $30bn of debt. Asset sales and cost-cutting have now trimmed that to $26bn, leaving the target of $18bn of net debt at the end of 2016 within reach.
Although these cuts to its veritable mountain of debt are impressive, the company’s gearing ratio remains a worryingly high 54%. With little prospect of another massive run-up in commodities prices on the horizon and higher debt levels than competitors, Glencore isn’t in a great position to sustain the current rally. Management’s decision to end dividend payments was a wise move to save capital, but combined with shares trading at a full 39 times forward earnings neither income nor growth investors will find the shares attractive for the foreseeable future.
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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.