Is Tesco PLC Due A Re-Rating?

Tesco PLC (LON:TSCO) may have too much on its plate at present to respond quickly to new developments.

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tesco2Tesco (LSE: TSCO) has been one of the big fallers so far this year, having plummeted by almost 50% to 178p. Its issues have been well documented and include a game-changing £250m misstatement in profit.

But Tesco is still a massive company. It has a market cap of £14.45bn, and is one of the largest retailers on the planet both in terms of revenue and profit (assuming it hasn’t misstated any more of this number…). Investors are fleeing the group and the selling pressure continues.

Currently hovering above 52-week lows and on a PER of 7.5x, we ask if this discount to historical PER is justified, and whether the former FTSE darling is due a re-rating.

The Story So Far…

It’s been a rough few years for the retail giant. By the time it was discovered that Tesco Value burgers got their ‘value’ by virtue of being 29% horsemeat in 2013, its sales had already been declining for years as deep discounters Aldi and Lidl ate up market share.

Fast forward to October 2014, and the potent mix of PR scandal and market-taking, disruptive competition sounds much the same as it did a year ago. Just substitute ‘horsemeat’ with ‘£250m profit misstatement’. Or ‘ongoing FCA investigation’.

This inquest could be damaging both in terms of what it unearths, and the manner in which it might compromise operational efficiency at a time when robust and flexible management is needed. Furthermore, Kantar data indicates that Aldi and Lidl continue to take market share.

Tesco has lost more ground than either Sainsbury’s or Morrisons. Nothing has arrested this trend and it is still too early for any strategic or tactical changes to make a difference.

Going Forward

As mentioned above, Tesco is the largest UK operator by some distance. The notion that bigger companies take longer to react to changing market conditions rings true here. This supermarket giant over-expanded in its glory days so it could keep the growth story going.

With restaurants to run and overseas stores to operate, in addition to its core UK business, Tesco may have too much on its plate at present to respond quickly to new developments. When this is considered alongside the FCA investigation, and the potential this brings for work disruption, it begins to look doubtful as to how well Tesco can react to events and keep pace with its peers.

This drives the case for the sale of selected assets. Tesco has so far rebuffed advances for its data analytics division and there are rumours of hedge funds sizing up Asian assets – such a sale could free up cash and allow management to focus more on the core UK retailing business.

Conclusion

All things considered, Tesco is cheaply rated at a PER of 7.5x for a reason; structural changes, sterner competition, protracted price wars (which may have significantly further to go), accounting scandals, food price stagnation, and diminishing fundamentals have all justified its current share price malaise.

Although performance might pick up on changing market sentiment alone, structural change continues apace, and it would be risky to buy shares until there is more earnings and performance visibility in the sector.

Tesco was once regarded as a safe long-term investment and a solid choice for dividend income. This may yet prove to be true in the future, but certainly for the short to medium term, these shares are a speculative risk.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jack Brumby has no position in any shares mentioned. The Motley Fool UK owns shares of Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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