Horror show

First of all, let’s not forget the scale of Tesco’s troubles. Shareholders have watched in horror as the UK’s largest retailer turned pre-tax profits of over £4bn in 2012 into a record breaking £6.4bn loss for fiscal 2015. As if that wasn’t dramatic enough, by 2016 underlying earnings had dwindled down from 40.31p per share to just 4.06p per share in just four years.

Loyal shareholders who’ve kept the faith in the nation’s favourite grocer have seen the value of their holdings plummet from 388p per share just four years ago to today’s levels of around 174p. A 55% share price collapse for a previously unshakeable blue-chip retailer is dramatic indeed. Longer-term shareholders have suffered even worse, with the share price now 65% below the 492p peak achieved in 2007.

New vision

As you’d expect, Tesco hasn’t been taking this lying down. The man who came in to lead the firm, the group’s CEO Dave Lewis, has been hard at work trying to regain competitiveness in the supermarket’s core UK business, while protecting and strengthening its balance sheet and rebuilding trust and transparency with the customer. No sooner had he moved into his new job than changes were afoot.

In January 2015 he announced the closure of the group’s headquarters in Cheshunt, Hertfordshire with the loss of at least 2,000 jobs, as well plans to close 43 lossmaking stores, and the cancellation of 49 new large supermarket developments. The group’s new headquarters are in Welwyn Garden City, also in Hertfordshire.

On Wednesday, the group announced that it had struck a deal to offload its opticians business to Vision Express for an undisclosed sum. The supermarket chain has an optician service in 206 of its larger stores, which will continue to operate but as a concession under the management of Vision Express. The move comes after a number of other non-core businesses have been sold off by the CEO in order to concentrate on its core UK supermarket business.

Mega-merger

But it hasn’t all been sell, sell, sell. In January of this year Tesco announced that it had reached an agreement for a mega-merger with Booker Group (LSE: BOK) to create the UK’s largest food group. Perhaps understandably there are concerns over market dominance with Tesco and Booker being the UK’s largest food retailer and wholesaler, respectively.

Full-year results released earlier this month provided some evidence that Tesco may have turned a corner, with operating profits climbing 29.9% to £1.28bn, and like-for-like sales growth being achieved for the first time 2010. I think it could be time to reconsider Tesco. The recovery plan seems to be taking effect, and dividend payments are expected to start again in 2018. The shares are also trading on a much lower rating than in previous years, with the P/E ratio falling to 14 by 2018/19. The glory days may not exactly be back but Tesco is looking increasingly attractive.

The post It’s time to consider buying Tesco plc again appeared first on The Motley Fool UK.

More reading

• Will Tesco shares plunge in May or June? This latest news spells trouble…
• £20,000 invested in Tesco shares 3 years ago is now worth…
• 5 years ago £10k bought 4,484 Tesco shares. How many would it buy today?
• Is now the time to consider buying Tesco shares?
• The Tesco share price is struggling to regain 500p even after strong results – where to from here?

Bilaal Mohamed has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

The big question is, will Tesco regret its decision to buy Booker? There have been some serious concerns about the state of Tesco’s balance sheet in recent years and paying up to acquire Booker won’t alleviate those concerns. 

What’s more, thanks to a vicious price war, Tesco’s operating margins have more than halved since 2010. Analysts see further price pressures on the horizon for Tesco, including price inflation and higher wages. 

Initial concerns 

Initially, after the deal was announced last week, analysts began to ask why Tesco, a retailer with a weak balance sheet was offering a price equivalent to 24 times earnings for Booker. However, after crunching the numbers analysts have started to come round to the idea.

Tesco is paying for Booker mostly in shares, to lessen any potential impact on its balance sheet. Booker shareholders will receive 42.6p in cash and 0.86 in new Tesco shares. The merger will result in Booker shareholders owning 16% of the combined company.

Further, Tesco says it can squeeze £200m of synergies from the deal. Potential cost saving ideas, such as using Tesco’s delivery vans for wholesale deliveries when they are currently idle between 5 am and 8 am, and offloading food not suitable for supermarket sale to caterers, have been put forward. 

To some extent, these potential synergies do justify some of the premium being paid. 

A bigger risk 

The biggest risk to the deal is competition concerns, something Tesco cannot do anything about. 

Booker supplies 5,463 franchise convenience stores while Tesco owns 3,569 shops, including 2,839 small stores, and over 700 ‘One Stop’ shops. Combined, the enlarged group would control 27% of the UK convenience store market and over 30% of the overall food market. The Tesco group would also have unprecedented pricing power over the catering industry.  

As the deal is set to create such a massive industry giant, analysts believe it could take two years for the Competiton Commission to provide a ruling as to whether or not the deal can go ahead. During this time plenty could go wrong. Tesco’s shares may sink, forcing the retailer to hand over more cash in the deal, or Booker’s shareholders may decide they don’t want to accept Tesco’s shares as currency and vote down the deal in favour of a higher cash offer. 

Conclusion 

Is Tesco’s offer to buy Booker a huge mistake? No, not yet. Right now it looks as if the retailer has chosen Booker as a way to bolt-on cheap growth in its home market where significant cost synergies can be achieved. That being said, if the Competition Commission rules against the deal, it may turn out to be an expensive mistake for Tesco. 

The post Could Tesco plc’s £3.7bn Booker Group plc deal be a huge mistake? appeared first on The Motley Fool UK.

More reading

• Will Tesco shares plunge in May or June? This latest news spells trouble…
• £20,000 invested in Tesco shares 3 years ago is now worth…
• 5 years ago £10k bought 4,484 Tesco shares. How many would it buy today?
• Is now the time to consider buying Tesco shares?
• The Tesco share price is struggling to regain 500p even after strong results – where to from here?

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