Tesco: Long Short Term... (Short Long Term?)

Aug. 1.14 | About: Tesco PLC (TSCDF)

Summary

Tesco share price at a ten-year low after last week's profit warning.

Incoming CEO is facing structural issues and weak trading.

We anticipate new CEO to "kitchen-sink" the FY earnings and outlook.

Nonetheless, it is time to buy at a low valuation point, before a series of catalysts.

Catalysts are: 1st diagnostic of the CEO, new strategy in the next 6 months, asset disposals, new hirings.

Share price at a ten-year low

Things at Tesco (OTCPK:TSCDF) (OTCPK:TSCDY) are getting worse and worse: last week, the company issued a new profit warning and fired its CEO, Phil Clarke, a Tesco lifer, after 3 years of disappointing results and a 35% decline of the share price, which is now trading at a ten-year low.

Incoming CEO facing structural issues and weak trading

Tesco faces structural issues that won't be addressed overnight: the group has too many and too big hypermarkets compared to competitors (especially in the UK), e-commerce is putting strong pressure on non-food/general merchandise offerings of the company, Aldi and Lidl price positioning and image pose a big challenge to Tesco, international ROCE are below expectations in a number of countries...

The visibility is low on future earnings, as the company only stated that trading profit for the half year will be "somewhat below expectations", and the impact on the full year will depend on the success of the ongoing price investments…

"Kitchen-sinking" ahead

Lastly, the new CEO will certainly "kitchen-sink" the full-year numbers.

The new CEO, Dave Lewis, has spent his entire career (30 years) at Unilever, his most recent position being president of Personal Care. His ability to switch to retail from brand manufacturing remains to be seen. At first glance, Unilever being one of Tesco major suppliers, the company should not be totally unknown to Dave Lewis. But retail and brand manufacturing are still two very different worlds, and the experience of Lars Olofsson, one of key executives of Nestlé (OTCPK:NSRGY) at the helm of Carrefour, has been a huge disaster (5 profit warnings, share price down 45% in 3 years).

Time to jump in?

Nonetheless, we feel there is, right now, a great opportunity to invest in a "slaughtered" stock at a fairly interesting valuation, with a series of catalysts in the near term.

Valuation

It is not an easy game to value Tesco today, as the visibility on earnings is pretty low, following the recent profit warning and probable kitchen-sinking of the incoming CEO. Tesco PE 2015 is around 11x, which compares to a sector average of 12x. So if the consensus is still 10% too high, Tesco would trade in line with peers. If the market starts to believe in a recovery story, Tesco would then trade on a significant premium to peers, as is the case for Carrefour, for instance (PE 2015 at 15x).

Here is the series of catalysts we have identified

October 1st, at the time of the interim results presentation, we should expect a first public appearance of Dave Lewis as Tesco CEO. He should only give a quick diagnostic of Tesco difficulties (quite easy) and deliver a Churchill-like message: "I have nothing to offer but blood, toil, tears, and sweat". This kind of introduction to the markets would be positively received, as investors know how difficult the Tesco recovery will be. Investor only want to see a charismatic and realistic leader heading Tesco.

Lastly, he should announce an Investor Day for Spring 2015, where he would present the full plan.

Spring 2015: The full plan would be made of strong price investments, store improvements/differentiation, improved service where needed, refocus on food... in a few words, back to basics! Exactly what investors think is the good formula to put Tesco back on track.

In the meantime, a mix of asset disposals (at higher-than-expected valuations, so positive surprise on Tesco SOP and share price) and hiring of retail/Tesco veterans will nourish a dense, positive news flow. Former Tesco CEO, P. Clarke got rid of a lot of valuable top executives. Rehiring one or two of them would be reassuring for investors and would compensate Lewis' lack of retail/Tesco experience.

Clearly a Buy for the next 9 months. Longer term, the Buy case is less straightforward...

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

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