Having Upped His Stake Buffett Is Expecting Tesco To Start The Fight Back

| About: Tesco PLC (TSCDY)

Tesco (OTCPK:TSCDY) operates multiple retail formats in 14 different countries and ranks among the top three grocery retailers in the world with the U.S.' Walmart (NYSE:WMT) and France's Carrefour (CRERY.PK) holding top slots.

Tesco is the leading food retailer in the United Kingdom, where it operates about 2,500 of its nearly 4,900 stores worldwide. Tesco holds approximately 30 percent share of the UK grocery market.

The day after Tesco warned that trading profits for its 2012 - 2013 financial year would be "flat," as it steps up investment in its home market following its worst underlying Christmas sales performance for decades, Warren Buffett's Berkshire Hathaway investment company increased its stake in Tesco from 3.21 percent to 5.08 percent.

Buffett's move did not come as much of a surprise as he had declared his interest in further purchases last November and that if Tesco's share price would fall he would buy up more shares.

The fight-back starts now in earnest

While we are expecting a strategy update in March or April, thus far Tesco has disclosed that it will rein in its out-of-town 'hypermarkets' expansion plans.

Instead, it intends to invest hundreds of millions of pounds in order to revamp the UK business; investing in "friendlier and more attentive" (additional!) staff, outlet refurbishments ("improving the shopping experience") and developing further online sales ("offering a multi-channel shopping approach").

Following on from missing out on some of its competitor's promotional couponing during the Christmas period, Tesco announced a new voucher campaign ("spend £40 in store and get a £5 voucher for next week's shop of more than £40") as part of its price-cutting programme, similar to the one Walmart-owned Asda was running before Christmas.

Commentators also expect further property sales of its properties globally as well as more sale-lease-back arrangements in order to unlock value from its huge landbank and property portfolio. Also expect a major push toward substantially more online and smartphone retail sales in the UK.

Is there a precedent in turning around Tesco's fortunes in the UK?

In the early 1990s, Tesco got initially badly hurt as a result of the aggressive expansion of Kwik Save and the arrival of several European discounters. At the time it responded by launching Tesco Value and subsequently the group developed the Tesco Club Card and Tesco Finest food range.

By the middle of the 1990s Tesco had established itself as UK's market leader. Will it be able to do something similar?

Comments by Phil Clarke, Tesco's chief executive, that apparently he has been doing much "soul searching" prior to the trading update about what went wrong ring rather hallow. With UK unemployment at high levels it's not as if all UK consumers have become cash-strapped suddenly over Christmas.

At least, Tesco has admitted that "the shopping experience" just wasn't as good as it should have been. Much more than soul searching is required to rectify the situation. A return to Tesco's archives in order to work out how it got out of the 1990s recession in such a successful fashion may well help.

What about outside the UK?

Not all is that rosy outside the UK.

While Tesco's Christmas results in the USA were much better than expected, it remains to be seen whether its U.S. operations can be turned around.

Problems are also storing up in Eastern Europe where consumers are hit hard by high inflation rates and austerity measures kicking in.

For instance, in increasingly nationalistic and Europhobic Hungary, where Tesco is market leader with a 19 percent market share, government plans to impose a "crisis tax" on retailers of 2.5 per cent which, some have indicated, could amount to a 'one-off' charge of euro 318 million in Tesco's case, while also proposing a ban on building new large stores.

Prospects for 2012?

Clearly the gloomy trading update can be best described as Tesco being hammered in the UK by 'premium' supermarkets and growing discounters. A process that has been going on for a number of quarters now.

Looking ahead, Tesco said that "while underlying profit before tax and earnings per share for 2011/12 will be broadly in line with market consensus forecasts, we expect group trading profit growth to be around the low end of the current consensus range." The question is, what "market consensus forecasts" is it referring to?

However, of all the major UK retailers Tesco is the only one with the prospect of significant growth over the next decade(s) via several new areas of business in the UK e.g. Tesco bank services, and its international operations.

What the City, the stockmarket and the media seem to have forgotten, hopefully only temporarily, is that growing earnings, and subsequently growing dividends will flow from Tesco's growing Asian emporium, in due course.

Let's not forget that already Tesco's Asian business activities are vast, spanning more than five emerging and rapidly growing developing countries such as South Korea, Thailand, and China.

To me it is clear that Asia will be key to Tesco's growth over the next 10 to 20 years. In fact, based on current growth rates, it is likely to surpass the UK before too long.

Ok, so let's factor in that Tesco UK is likely to be suffering with no or low growth rates during the next few quarters. As per Tesco's statement profit growth would be "minimal" in its next fiscal year.

However, we should also not forget that the UK still remains its prime cash cow, albeit perhaps somewhat shrinking currently.

Utilising this wisely will be key to turning around the situation in the UK and to support growth elsewhere. This should allow overall earnings to keep growing following this episode, resulting in dividend growth going forward. But not necessarily the next few months!

The City, et al, appears to focus way too much on monthly UK like-for-like figures than those looking for a company with both a good overseas growth story as well as prospects.

Also, is Pound Sterling going to remain strong forever? Any weakness here and with overseas like-for-like sales and results growing, when converted back to Sterling, overall results will return to growth in no time.

Finally, is the dividend safe?

Good question!

I have been mulling about this for some time now. I still believe Tesco will increase its dividends for calendar 2012, albeit at a substantially slower pace in comparison with earlier years. Perhaps even below the 2012 UK inflation rate.

It's important is to remember that Tesco is the only FTSE100 company with a track record of increasing its dividends during the last 27 years. I am sure it does not want to lose that record. Even a token increase should 'calm-down' long-term dividend income investors.

During the last 12 years, Tesco's calendar CAGR dividend increase rate amounted to a massive 9.8 percent (massive in a UK context). This even includes last year's dividend annual growth rate, which amounted to just 4.83 percent. At this stage, we suggest that the 2012 dividend growth rate is unlikely to be more than 2.5 percent.

Tesco's dividend yield is now approaching 5 percent. It's well ahead of the FTSE 100 as a whole at 3.5 percent and obviously outstrips anything a bank deposit can offer. Its prospective dividend per share payout, for the year ending February 2013, is covered more than twice by its earnings.

Disclosure: I am long OTCPK:TSCDY.

Additional disclosure: We run the Dividend Income Portfolio, which owns a shareholding in Tesco Plc, purchased during 2011 and most recently in 2012, following the trading profits update. At current levels, Tesco remains historically undervalued as per our valuation methodology.