Tesco (LSE: TSCO) is a stock that tends to divide opinion. On one hand, there are plenty of investors who believe that the company has bright prospects ahead and that the share price offers value. On the other hand, many investors see the investment case as quite risky. Personally, I’m in the latter camp. Here’s why.
Lack of economic moat
One of the first things that Warren Buffett looks for in a stock is a competitive advantage or ‘economic moat’. What this does is protect the company profits. Imagine that the company is a castle – if it has a wide moat around it, it’s more protected from enemies (competitors) meaning its profits should be more resilient. If there’s no moat, there’s nothing to stop enemies from raiding the castle (i.e. competitors stealing market share). “The most important thing is trying to find a business with a wide and long-lasting moat around it,” Buffett says. “Why is that castle still standing? And what’s going to keep it standing or cause it not to be standing five, 10, 20 years from now?”
Now, in the past, Tesco’s competitive advantage was that it was the largest supermarket in the UK. This meant that it could buy in scale, offer competitive prices, and generate solid profits. That model worked well when it was just the big four supermarkets – Tesco, Sainsbury’s, Morrisons, and Asda – in the UK. However, that competitive advantage appears to have been smashed to pieces by the arrival of Aldi and Lidl, who have disrupted the market in recent years by offering far lower prices than the big four, and have managed to capture significant market share.
Just look at the most recent UK supermarket data. For the 12 weeks to 9 September, Tesco’s market share fell from 27.4% to 26.9%, while Aldi’s market share increased from 7.6% to 8.1% and Lidl’s increased from 5.5% to 6%. This is a trend that we have seen for a while now. Clearly, Tesco’s economic moat has been breached. And looking ahead, I believe things could get worse for it.
Aggressive growth plan
Just last week, Aldi – which has won a stack of supermarket awards in recent years – announced plans to open a new store in the UK every week on average for the next two years. The group is also now targeting London. “Within Greater London, our market share is around half of what it is in the rest of the country so there’s clearly a big opportunity for us to expand the business. In the long term, we can comfortably see us opening 200-250 stores within London,” said Aldi boss Giles Hurley.
I see this as bad news for Tesco, as with more stores open, Aldi should be able to continue to capture market share at the expense of the big four. Throw in Lidl’s plans to open 40 new stores in London in the next few years, and the long-term outlook for Tesco looks quite uncertain, in my view.
So, given its clear lack of economic moat, I’d be inclined to give Tesco shares a miss. To my mind, the current forward-looking P/E ratio of 14.7 doesn’t offer enough value when you consider the risks to the investment case. All things considered, I think there are better stocks to buy right now.
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Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.