TSCO.L - Tesco Plc

[cr6196]

Not really new news as this has been anticipated for a while but...

 

http://www.standard.co.uk/business/business-news/tesco-finance-chief-laurie-mcilwee-poised-to-depart-9237454.html

 

Not surprising, fallout from Terry Leahy continues. Also starting to sound like Clarke tried to leave but everyone bolted before he could get out.

[klarmanite]

Not liking this (when has this ever been a good sign). Results on the 16th will be very interesting.

[klarmanite]

 

http://www.4-traders.com/WM-MORRISON-SUPERMARKETS-9590120/news/British-grocers-struggle-as-German-discounters-expand-18226040/

 

 

British grocers struggle as German discounters expand

04/08/2014 | 07:52am US/EasternRecommend:

 

Britain's major supermarkets are cutting prices but will struggle to stop Aldi and Lidl eating their profits as the German discounters look to double their share of the 170-billion pound grocery market in the next three years.

 

Market leader Tesco (>> Tesco PLC), Wal-Mart owned Asda (>> Wal-Mart Stores, Inc.) and Morrisons (>> Wm. Morrison Supermarkets plc) have together pledged to make price cuts worth 2.4 billion pounds though analysts question whether they can compete on those terms with the discounters, whose no-frills focus on value won affluent new shoppers in the recession and look set to win more in the fragile recovery.

 

Sainsbury's (>> J Sainsbury plc), the other member of Britain's big four, has proved to be more resilient to the discounters and has sounded less alarmed by what Morrisons has called a "paradigm shift" in grocery retailing. However, even it will not be immune from broader industry price cuts should they transpire.

 

As a result, investors will need to get used to shrinking profit margins, especially as food producers and suppliers seem better able than before to defend their own charges and prevent themselves ending up losers in a price war.

 

In February, Tesco effectively abandoned its target for an operating margin in the British market of 5.2 percent, the highest in the industry. "The margin will be what the margin will be," it said.

 

With Tesco, Asda and Sainsbury's all operating price matching schemes - guaranteeing not to charge more than rivals for the same product - the scope for contagion is high.

 

Some analysts question, however, whether waging a price war alone can hold off the rise of the German bargain grocers.

 

"It's rather like British Airways trying to compete with Ryanair on price," said Ed Garner, director at market researcher Kantar Worldpanel. He reckons a move to slash prices from the big four could reduce profit margins and damage balance sheets but not significantly increase sales.

 

Forecasting Aldi <ALDIEI.UL> and Lidl <LIDUK.UL> could double their market share, Garner said: "The low-cost element of the low price is so engrained into Aldi and Lidl culture it's quite difficult to emulate that with a different supply chain."

 

LOWER PRICES

 

Asda started cutting prices last year, saying it would spend 1 billion pounds over five years, but is yet to see a turnaround in its sales performance.

 

In February, Tesco said it would spend 200 million pounds on lower prices for basic products and a similar amount on a fuel savings scheme for holders of loyalty cards. Last month, Morrisons said it would invest 1 billion pounds in holding down prices over the next three years.

 

The big four are also working harder to extol what they have and what the discounters do not, be it more brands, more choice, general merchandise, online shopping, fuel, retail services such as banking and insurance, smarter stores and more staff.

 

However, Bruno Monteyne, an analyst at Bernstein Research, reckons both Tesco and Morrisons are still struggling to differentiate their offerings, meaning they lose customers both to the discounters and to upmarket grocers Waitrose <JLP.UL> and Marks & Spencer (>> Marks and Spencer Group Plc).

 

Although Aldi and Lidl still have a fairly small combined share of the British grocery market at 8.0 percent, according to the latest Kantar data on Tuesday, they are seeing growth of 35.3 percent and 17.2 percent respectively, while their bigger rivals struggle to eke out any growth at all.

 

Shore Capital analyst Clive Black said the big four were dealing with a customer revolt: "People have basically said 'I don't want your promotions, don't trust your price matching and more to the point, I am going to try something else'."

 

Sally Young, a personal trainer, from Dorking near London, is typical of those switching. "My cleaner told me Lidl was very good," she said. Young tried it, liked the prices for staple goods, such as bread, milk, butter, cheese, salad and fruit and found the quality "generally good". She is now a regular.

 

Lidl, which opened in 1973 to challenge the older Aldi brand, launched in Britain in 1994 and now trades from about 600 stores in the country. It plans up to 20 openings in 2014 and 20 to 40 a year after that. It is owned by Germany's third-richest man, Dieter Schwarz, son of the founder.

 

Aldi opened its first British store in 1990 and now trades from 514 stores there. Controlled by Germany's richest man, Karl Albrecht, it has an ongoing plan to open 55 new shops a year.

 

Both chains have thrived by offering low prices in one of Europe's richest countries, appealing to instincts for thrift. They keep prices down by selling mostly own brand items, bought in bulk and piled high, sometimes still on warehouse pallets. Staff are few and there are no loyalty schemes.

 

Their international reach has given them considerably buying power, helping them keep down costs.

 

Together they enjoy market shares of 33 percent in Germany, 24 percent in Austria and 18 percent in Ireland and Belgium - much higher than the 12 percent discounters peaked at in Britain in the 1990s when home-grown budget chains were significant.

 

FUNDAMENTAL SHIFT

 

"It's not since the late 1950s and the advent of the supermarket have we seen this sort of change in the market," Morrisons Chief Executive Dalton Philips said last month, as he issued a hefty profit warning.

 

"This is not cyclical; there's been a fundamental shift in how consumers view discounters. If we don't address it we will continue to lose more. You can see their growth in Europe."

 

Some, like Sainsbury's Chief Executive Justin King, believe Philips exaggerates the threat because Morrisons is particularly vulnerable to the discounters, given its late entry into fast-growing convenience and online areas. But there is no doubt they are now a major force in the British grocery trade.

 

More than half of Britain's shoppers now visit discounters and are increasingly using them in the same way they would a traditional supermarket to do a full shop rather than a top-up.

 

More and more middle-class customers are coming through discounters' doors. Lidl for example says the proportion of its customers from the more affluent "ABC1" and "AB" demographics now stands at 51 percent and 24 percent respectively.

 

According to data from market researcher Nielsen, Aldi's average basket size of almost 17 items is now more than Sainsbury's and on a par with Morrisons, despite it carrying significantly fewer product lines - about 1,350 versus 30,000-40,000 at the big four.

 

"People want to, rather than need to, shop at Aldi," the Ruhr-based company said of its British operations.

 

While the discounters enjoy a price gap versus the big four - for example Aldi typically sells 2.5 kg of potatoes for 1.89 pounds versus 2.00 pounds at Tesco and Asda - the gap between the perception of discounter quality and that of the traditional grocers is closing, according to research group Millward Brown.

 

That has been helped by the discounters broadening their fresh produce ranges, sourcing more British produce and their promotion of more high-quality products. Quirky television ads have also helped.

 

Aldi's Easter product range includes whole quails, whole stuffed pheasant and a four-bird roast, while Lidl's includes Aegean sea bass fillets and three-fish roast.

 

Sainsbury's King, who will leave the grocer after 10 years at the helm in July, appears the most relaxed of the traditional market leaders to the discounters' threat, reflecting the firm's outperformance of its three big rivals in recent years.

 

He insists he is not complacent but says discounters are simply not a new phenomenon: "Overall it's part of the cut and thrust of the market," he said. "It was ever thus."

 

(Additional reporting by Neil Maidment and Emma Thomasson; Editing by Alastair Macdonald)

 

By James Davey

 

[jay21]

"Here is the Tesco share price, which you might notice is getting into lost decade territory."

 

"There’s more than one difference to spot actually. Sales are up 111 per cent over the interim decade. Profits before tax are up 91 per cent, and earnings per share are up 97 per cent.

 

Returns have improved as well, at 12.5 per cent of capital employed, versus 10.5 per cent. Although all those double digit growth numbers are absent these days.

 

But one number for which you have to go looking for in the 2004 annual report is capital investment. This was £2.2bn in 2004 and only a fifth higher a decade later, at £2.7bn. Look at it on a capex to sales basis and the ratio has dropped from 6.5 per cent to 3.8 per cent."

 

 

http://ftalphaville.ft.com/2014/04/16/1831252/spot-the-difference-tesco-edition/

 

 

[klarmanite]

Results were not as bad as expected, margins were stronger than consensus expectations implied. Listening to the conference call, I was relieved to see no sign of a strategy change and several signs of the store remodels working in the UK and a continued commitment to reducing capex and focusing on Tesco's offer, rather than pleasing the analyst community with short term price cuts and the like. (I was also struck by the pervasive bearishness from the sell-side analysts present). Still long Tesco.

[klarmanite]

Bestinver bought 3m shares in Q1: http://www.gurufocus.com/news/257337/spanish-investor-francisco-parames-five-new-firstquarter-stocks

 

[klarmanite]

Interesting write-up that's focused on the real estate assets. http://seekingalpha.com/article/2112993-tesco-buy-the-property-get-the-retailer-for-free

 

[topofeaturellc]

Eh. Bad Trading Update today, but a new CEO.  I like this controversy but prefer SBRY because I think less of its business is at risk of migrating to the hard discounters.  I hope this new guy doesn't think a price war is a good solution, or ramping up store investment.  Focus on reducing OPEX and generating FCF by reducing capital spend.  Industry seems way overbuilt, way over-margined compared to the US.  Will be interesting to see.

[WhoIsWarren]

I believe that replacing "Big Phil" does more harm than good.  I'm with David Herro (CIO Harris Associates) on this one.  In short, Herro's argument is (was!) give Phil Clarke another 18 months because he's doing the right thing and results take time to come through.

 

Besides, there's a lot going on in the company and the UK food retailing industry that are beyond the control of the CEO, no matter who that person is.  Clarke did a lot of the things we would have wanted him to do: get out of international markets where you have no advantages to bear, invest in your stores where previous management ("Sir" Terry) hadn't.  Unless the Board could clearly see that Clarke wasn't the man for the next 10 years -- in which case they should have a long hard look at themselves because pretty much the whole Board (with the notable exception of the Chairman) was there when Clarke, the internal candidate, was appointed -- then they should have left him alone. 

 

The analyst community and the press were all over Tesco management and I believe had a big influence on (short term) Tesco investors.  What does the Clarke episode tell the incoming management team?  What are they going to tell their regional managers -- and they in turn tell their store managers?  Most likely this: forget about the 5-10 year plan for the company: cut corners and get earnings up....fast!! 

 

Ironically, as it happens there was an article / interview in today's FT (FTFM) that addresses the topic of investing for the long term.  See link below.  The guy believes in family-controlled businesses.  “It’s not because [companies with large family stakes] are smarter, it’s because they tend to invest in the future.”

 

http://www.ft.com/intl/cms/s/0/d4f10fa2-0b5a-11e4-ae6b-00144feabdc0.html#axzz387DQxUDj

[topofeaturellc]

I think some of that depends on how broken you think TSCO's model is.  With the advent of hard discounters does the "most things to most people" model work?  If you are questioning that bringing someone in from outside may not be the worst idea. It might be too early but the board might be thinking rather too early than too late.

 

Although I agree - the crux of TSCO's problems don't really have much to do with managements historic actions. 

 

The problem may not be a 5-10 year plan, its that there is some chance that your old 5-10 year plan is no longer viable.

 

 

[ukvalueinvestment]

Tesco is a value trap, IMHO.

 

Food retail is a massively competitive and commoditised busininess.

 

Aldi and Lidl and others have taken the value space.

 

Waitrose and speciality shops and even Sainsburys have taken quality.

 

Online is completely changing the whole industry and making it far less profitable.  The wealthier the demographic, the more likely they are to use online, where margins are much smaller.

 

And ... it's just not that cheap...

 

 

[topofeaturellc]

As I said - I prefer SBRY - but I don't think any of them are truly cheap unless they throttle back on the capital investment.  I'm probably being too cute but I think there is a  more bad news to come on comps and GM so I'm not rushing in.  Tho I'd love to see one of the three players announcing a big reduction in capital spend. 

 

I tend to agree on TSCO.  Have you seen the work the Bernstein guy has done showing how Walmart entering the US as a food retailer impacted share for different types of competitors? I thought it was quite good despite my innate dislike of sell-side research.  Also instructive to look at the Dutch example.  Basically moderately high end does best.

 

UK is quite interesting compared to the US - much more capital intense - even adjusting for RE costs - with much higher margins.  Seems Aldi and Lidl are much close to the lower capital intensity model that dominates in the US.

[ukvalueinvestment]

Why would you invest in an industry that is ultra competitive and becoming structurally less profitable?

 

Sainsburys has done very little for ten years.  What makes you think anything has changed?

[topofeaturellc]

Because I think its cheap and outside of some capital discipline I don't actually need SBRY to do any better than its done for the last five years for me to do well.

 

I'm not so much concerned with business quality above and beyond a decent return on tangible capital.  Which is like 8%- 9% long-term for SBRY.  If you thought that had changed then sure.  I also like capital intense businesses that are going through cyclical reductions in capital investment because of pricing issues.  It tends to work out well.

[ukvalueinvestment]

Your cost of capital is 8-9%?

 

I gotta say - I don't know where UK retailers are going to make incremental investments going forward.  The market is totally saturated.  Small city branches have been the trend over the last 5 years or so, and they've sprung up everywhere.  Far less profitable than big stores and I'm surrounded by them.

 

Please don't do this.

[topofeaturellc]

That ROTC not ROTE so its actually probably less right now.  Them not having investment opportunities is good for me. It means they have to use the cash for things that accrete value to me as an equity holder.

 

I'm really very comfortable with investing in mediocre businesses like this.  If there wasn't a reasonable case for not buying it, It might not be an interesting idea. 

 

If this idea doesn't work that's ok, but it'll be because the hard discounters impact SBRY as much as they will probably impact TSCO and MRW. Or they never get capital discipline - in which case I probably just don't make any money.

[WhoIsWarren]

Thanks for all the replies.

 

The debate over the hard discounters in the UK is interesting, but I wonder has the balance of the debate swung too far?  Let's put it in perspective, Tesco has 25-30% market share in the UK / Ireland.  Aldi / Lidl have something like 7 or 8% in the UK and around 15% in Ireland.  Tesco must have some scale advantages over the discounters (logistics, marketing??).  Yes, Tesco carries far more SKUs than them, so on a per-item basis the advantage mustn't be as great.  But I've got to believe that all the brains in Tesco can figure out a way to best use their muscle -- I don't know, something crazy like reduce the number of SKUs (while keeping the same broad range of products that appeals to a "time poor" customer like me).  Or, if it came to it, reformatting a portion of their (appropriately small) stores into hard discount stores?

 

I do not believe this is a case like say the low-cost airlines versus the flag carrier airlines that emerged 20-30 years ago.  In that case, the flag carriers had a massively inflated cost base that they couldn't reduce, while the blank-sheet-of-paper guys like Southwest / Ryanair operated on a far lower labour cost base.  Is there any part of the Tesco cost base that is not fixable?  Their biggest problem is probably the largest stores.  Clarke admitted a while ago that they probably built too many of these.  Can they fix this?  I think they're already looking at this, such as rearranging the store layout and introducing more "store within a store".  It's real estate after all that should more or less hold it's value over the long run, as opposed to the contracted high wages the airlines were paying that was money down the drain.

 

And let's think of the positives.  I could be wrong, but I don't believe Aldi / Lidl and their ilk can ever appeal to more than a small (say 15-20%) segment of the population.  What about home delivery?  The discounters are unlikely to ever be able to do it -- Tesco has a huge lead over EVERYONE (in the UK / Ireland, perhaps elsewhere) in this.  Tesco is beginning to roll out dark stores in the UK, which will appeal to another segment of the market.  And convenience too.  So they've lots of ways of reaching the customer.  The discounters have one!

 

Another area of self-help is that Tesco has fallen behind in its use of data they collect from customers.  This is ironic given that Tesco owns customer science company Dunnhumby.  Dunnhumby has teamed up with Kroger of the US with great success.  Tesco admits this deficiency and I'd be surprised if there weren't big strides made in the next 5-10 years on that front.  Again, Lidl / Aldi (at least in my experience) don't collect data at all so are miles behind.

 

And speaking of Kroger, let's look at their model.  They continually invest in price and get increased volumes on the back of it.  So their operating margins are something like 3.5% (versus Tesco's of a few years ago of c.6%), but their asset turns are great, meaning healthy Return on Equity (I'm thinking something like 20%, but stand to be corrected).  So the investment community is down on Tesco because of a margin that well, looks like it could be heading for 4%, at which point it'll be trading on say 13-14x earnings.  Kroger, which is facing all the discounter / internet etc. problems Tesco faces, is trading on c.20x or so.

 

I'm not suggesting this is a home run or anything, but investors are pretty down on this stock following a number of warnings.  It looks like a turn around, such that there could be one, will be a while away, so there's little for the short-term guys to like.  The company knows its very much under scrutiny and is unlikely to do any crazy capital allocation moves anytime soon, which is more than you can say for a lot of companies out there!!  Isn't there anything to like about this stock???

 

ukvalueinvestment, call me unambitious, but my cost of capital is, well yes, something like 8-10% or so.  I'd love it to be higher; there just aren't that many 10-baggers out there anymore..... ;)

 

 

[topofeaturellc]

Its hard to say where it ends up - Share in Germany and Norway is like 30%-40%. Benelux is like 20's - 30's but I think France topped out around 15%. But even at 15% in a fixed cost biz like grocery retail - its going to be tough for TSCO and MRW not to make huge changes. 

 

Its an interesting business model.  Yeah they carry very few SKU's and have a lower Opex cost on the stores - but what they've also been able to do is basically sell mid-level private label at value price points.  Its really killer. And don't forget private label penetration is much higher over there as well.

 

So its basically better product and lower operating costs.  Tesco's offering unfortunately competes with them too much at the low end.  They could retrench just to focus on the SBRY market - but in that case I suspect they are way overstored/stores are too big - which is going to be a not a lot of fun restructuring.

 

TSCO itself was basically the low-cost airline when it was a "great" business.  They grabbed tons of share from the incumbent with a new model.  I don't think its unthinkable that they might be this victim?

 

But to me I'd just like to see some strategy from them.  Assuming they don't purse the MAD of a price war any strategy announcement would be a good one - at least as long as it isn't willfully dumb.  I sort of suspect the MRW strategy of going at them head on is in the "willfully dumb" camp.

 

Leaving aside the idea that Kroger may or may not be overvalued - you've basically hit on something that's different about the UK retailers - way more capital invested in exchange for way higher margins.  I think we can understand the reinvestment economics of why this happened - but I think real estate costs aside its inevitable that they move to a higher turn lower margin model - because that translates to lower prices for the consumer.

 

I agree with your logic in the end. I just think there's a chance that TSCO is more screwed than SBRY.  I'll caveat that by admitting I never got the "great company" hype surrounding TSCO - at least over the last ten years or so when I was sorta paying attention - so I'm more likely to think their return profile looks more like the rest of the industry longer term.

 

ETA: well let me rephrase. Once SBRY gets below 300 or 290 I'd like TSCO to present a strategy that doesn't involve a price war.

 

 

[WhoIsWarren]

topofeaturellc, thanks for the reply and well-made arguments.

 

My market share guesstimate could of course be well off.  I probably shouldn't have put in a figure at all!  All sorts of cultural (attitudes to thrift / brands) and demographic factors (pensioners versus those with young families) are at play there.  You are right about dealing with the effects of negative like-for-likes when ceding share to Aldi / Lidl: very painful.  :o

 

I never looked at Tesco during the "great" years either.  An industry-like return is probably a fair assumption for it going forward, with a free option that they somehow make the most of all their potential advantages.

 

As an interesting aside, I recently spoke to some former industry execs who met a number of senior Tesco guys on an MBA-type gig during the "great" Leahy years.  The Tesco guys were so arrogant.  It's no wonder they fell.  I guess the positive now is that the swagger in their walk must be all but gone at this stage!

 

You could be right regarding Sainsbury over Tesco, but I'm thinking we're both essentially in the same boat (with one of us in first class, the other in economy).  ;)

[peter1234]

Rather than pointing out small market shares of Aldi and Lidl I would point out that they managed to gain a foothold relatively quickly. Going forward it might actually be easier for them to keep growing since they now have a performing infrastructure and scale.

 

Changing an expensive bureaucratic culture with corporate overhead and a fleet of corporate jets will not be easy. Best will be to get out of the hard discounters way and not compete on their turf.

 

:o

 

If the option existed, investing in UK Aldi /Lidl might actually be more attractive.

 

Would certainly want to see credible signs of a turnaround of the others before considering them.

;)

 

[topofeaturellc]

Value investing works because people want to wait to see the turnaround.

[klarmanite]

I threw in the towl on Tesco after the recent management change. Obviously, Clarke's plan was either not working or working very, very slowly. A new strategy (what is it?) sounds ominous to me.  Luckily, the pound strength recently reduced my loss considerably as my TSCO position was unhedged. The stock is cheap, but I am cutting my loss and moving on.

[ukvalueinvestment]

There was a documentary called Dispatches on UK TV this week about the supermarket industry and the massive changes it is undergoing and why incumbent retailers like Tesco are getting crushed.

 

The whole industry is becoming structurally less profitable - fact.

 

If you want to see it, it should be on Channel 4's online viewer - 4 on demand (4OD).  Dispatches.

[peter1234]

There was a documentary called Dispatches on UK TV this week about the supermarket industry and the massive changes it is undergoing and why incumbent retailers like Tesco are getting crushed.

 

The whole industry is becoming structurally less profitable - fact.

 

If you want to see it, it should be on Channel 4's online viewer - 4 on demand (4OD).  Dispatches.

 

Thanks, this is interesting.

 

I would rather invest in UK Aldi/ Lidl...

:D

[valueyoda]

The UK supermarket industry has simply overearned in the last few decades. Tesco will have to reinvent itself to coop with structurally lower gross margins and have to plow back billions of pounds of CAPEX into store redevelopment. The current dividend will be unsustainable, if the company wants to reinvent itself. Furthermore, a significant portion of the real estate has been assigned to several JVs that have already levered up. There is little room to monetize the real estate without pressuring the operating results in the UK.