Can Tesco shareholders hope for a recovery?
Retail giant Tesco has today announced a £6.38 billion loss, the largest in its history.
How could such a behemoth record such an enormous loss? And what does it mean for existing and prospective shareholders?
Tesco's nightmare 2014/15
Tesco's loss is the sixth largest in UK history, following Royal Bank of Scotland, Vodafone (twice), Lloyds Banking Group and Cable & Wireless.
There were a number of contributing factors. Sales slipped by more than 3% year-on-year, while trading profit more than halved, dropping to £1.39 billion from £3.3 billion.
But what really sent Tesco hurtling to its largest-ever loss was around £7 billion of impairments, write-downs and write-offs, including:
- £4.7 billion of property impairments (including £925 million for abandoned store openings), as Tesco reduced the value of the 68 million square feet of property it owns;
- £878 million written-off in goodwill at subsidiaries, including £630 million for its Chinese joint venture;
- a £570 million charge for writing down stock that had fallen in value;
- £416 million in restructuring charges as Tesco cut jobs and closed stores;
- £208 million for overstating commercial income in previous years;
- lastly, another £200 million in write-downs for UK subsidiaries, including Dobbies garden centres and Harris + Hoole coffee shops.
These are the maiden set of results for Tesco's new CEO Dave Lewis, and he looks to have got as much of the bad news out as possible. By putting so much red ink into Tesco's 2014/15 results, future-year comparisons will look much more attractive.
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Troubled times for Tesco
[SPOTLIGHT]The bad news for Tesco's hopeful shareholders is that its market share, sales, operating margins and profits are all falling. What's more, the grocer's net debt has surged from £6.6 billion to £8.5 billion in just one year, so its debt pile now equates to almost half (45%) of Tesco's market value.
On top of that, Tesco's pension 'black hole' (the shortfall between its pension fund's assets and liabilities) has surged from £2.6 billion to £3.9 billion. It's now the fourth-largest in the FTSE 100. As a result, the firm has agreed with its pension trustees to pump £270 million a year into the fund to reduce this deficit.
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The fundamentals of Tesco shares
With Tesco's troubles now out in the open and hopefully in the past, what can shareholders look forward to? Let's check the fundamentals of its shares to see what is on offer.
As the time of writing, Tesco shares trade at 223.6p. This means that they have:
- a forecast price-earnings ratio (PER) of 21.4, making them highly expensive for a high-street retailer;
- a projected dividend yield of 0.6%, which will not appeal to income-seekers, after Tesco decided not to pay a final dividend for 2014. Then again, analysts are forecasting EPS growth of 15% in 2015/16 and 28% the year after, leading to a tripling of the dividend yield to as projected 1.7% by 2016/17.
As things stand today, Tesco's problems are very visible. It is losing market share to deep discounters such as Germany’s Aldi and Lidl, while increased product promotions and price discounting mean its sales and profit margins are being eroded. In addition, capital expenditure is being halved from £2 billion in 2014/15 to just £1 billion in 2015/16, so its stores are likely to suffer by looking a little shabbier.
Lewis may seek to draw a line under the past and begin to rebuild, but I'm unconvinced. Healthy retailers must grow their top-level sales, gross margins and free cash flow. As Tesco is failing across all three of these critical measures, I would not be a buyer of its shares at their current price.
They are too expensive, offer too small a dividend, and already have too much hope baked into them.
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