Six years ago, Tesco (LSE: TSCO) was seen as the champion of the British retail sector. The group’s aggressive expansion, both here in the UK and overseas had helped Tesco grow into one of the world’s largest retail group’s and the firm had also won the support of billionaire Warren Buffett. In fact, Buffett’s belief in Tesco was so strong that it was of his first ever substantial investments outside of the US.
With Buffett’s support, it seemed Tesco could do no wrong. In 2010, shares in the company hit a post-Financial Crisis high of 450p while the rest of the market was still suffering. Between the end of 2006 and the high in 2010, shares in Tesco returned 13% excluding dividends compared to a loss of 9% for the FTSE 100.
Lost glory
Tesco’s glory days are now unfortunately behind the company. The rise of the budget chains and the firm’s 2014 accounting scandal have put a tremendous amount of pressure on the business. Warren Buffett sold his stake in the retailer several years ago, and management has been carving up the Tesco empire to pay down debt and stave off insolvency. The dividend has been cut to almost nothing and since the beginning of 2014, shares in Tesco have lost more than 40% of their value.
Tesco is a shell of its former self and the company may never be able to its former glory. Indeed, over the past few years the UK’s retail sector has undergone massive structural changes as price-focused rivals such as Amazon, Aldi and Lidl squeeze industry margins. And even despite the fact that Tesco remains the UK’s largest retailer, the company’s size hasn’t been much of an advantage when it comes to undercutting competitors and attracting customers into stores.
Over the past few years, Tesco’s operating profit margin has fallen from more than 5% to less than 2% and there’s no sign that the structural changes pressuring the business will disappear any time soon. Not only is the group suffering from the knock-on effects of a grocery sector price war, but Tesco is also having to navigate higher costs in the form of staff wages, pension obligations and large format stores, which are now falling out of favour with consumers.
A different company
During the past six years, Tesco has been forced to undergo a radical overhaul as the UK’s retail sector has changed dramatically. The changes mean that it’s going to be difficult for Tesco ever to return to its former glory. Even if the group can rekindle sales growth, profit margins in the industry are thinner than ever.
For the year ending 22 February 2014, Tesco reported a pre-tax profit of £2.2bn. City analysts don’t expect the group’s pre-tax profit to even move back above the £1bn marker again until 2019 – that’s if the company meets City expectations for sales growth. Based on current figures shares in Tesco are currently trading at a forward P/E 26.
