Tesco (LSE: TSCO) has a commendable practice of publishing analysts’ forecasts on its corporate website. Unhappily for shareholders, updated forecasts, which have just been published, suggest the company’s shares have further to fall.
The troubled supermarket’s shares are trading at 225p at the time of writing. I think they could drop below 200p — a level not seen since May 2003.
Earnings downgrades
Let’s begin with the forecast numbers. The table below shows the new consensus estimates for underlying diluted earnings per share (EPS), and the estimates as they stood before Tesco’s news releases of 21 July (profit warning and appointment of new chief executive) and 29 August (further profit warning, 75% interim dividend cut and bringing forward the start date of the new chief exec).
| Year to Feb 2015 (p) | Year to Feb 2016 (p) | Year to Feb 2017 (p) | |
| New consensus | 20.57 | 19.12 | 20.76 |
| Old consensus | 25.96 | 26.67 | 27.86 |
As you can see, before the news of 21 July and 29 August, the analysts had expected Tesco’s EPS decline to bottom out at 25.96p in the company’s current fiscal year (ending February 2015). The new consensus is for the trough to come at 19.12p in the year to February 2016.
This continues a pattern that has been running ever since Tesco’s profit warning of January 2012: time and again analysts have put the bottoming out of EPS back a year. At some point they’ll be right, but whether next year will prove to be the nadir is a moot point.
The shares should be 200p already
Even if the analysts have finally got it right, I think we could still see Tesco’s shares slump below 200p in the coming months.
Between the publication of the old consensus on 7 July and the profit warning on 21 July, Tesco’s shares traded at an average price of 283p. That put the stock on a forecast P/E of 10.6 for the year ending February 2016.
After the EPS downgrades, and with the shares now trading at 225p, we’re looking at a P/E of 11.8. Put another way, the 20% fall in the share price since July doesn’t fully reflect the 28% downgrade of next year’s EPS. If Tesco’s shares were trading today at their pre-21 July P/E of 10.6, the price would be little more than 200p.
Waiting
My view is that the departure of old chief executive Philip Clarke and arrival of new boss Dave Lewis has limited the extent of the decline in the share price.
I suspect many holders who would otherwise have sold and taken a capital hit are now waiting to hear the new chief exec’s plans for turning the business around before making a decision on whether to dispose of their shares.
I also suspect many investors who hold Tesco shares specifically for dividend income are waiting, too. The company didn’t make it clear whether the 75% cut in the interim dividend would also apply to the final dividend, and analysts are divided on the matter.
History says
The history of new chief executives coming in to turn around ailing supermarkets (including Justin King at Sainsbury’s and Georges Plassat at Carrefour in recent times), tells me Tesco’s Mr Lewis will offer no quick fix, but a three-year-plus recovery plan. I also expect the 75% interim dividend cut will be carried through to the final.
If I’m right, when Mr Lewis announces his strategy, the enormity and timescale of the task facing Tesco will hit home to many jaded shareholders who have been sitting on their hands hoping for light at the end of the tunnel sooner rather than later.
Selling pressure will rise and we’ll see Tesco’s shares falling below 200p to properly reflect the current consensus earnings forecasts, the risk of further downgrades, and the opportunity cost of holding a stock that pays only a meagre dividend as compensation for a long wait for recovery.
I reckon a dip below 200p could represent the final ‘capitulation’ that smart contrarian investors look for as a signal to start buying.
