Warren Buffett has 1 billion pounds ($1.6 billion) riding on Tesco Plc turning around its U.K. business. He’s not alone in backing Britain’s biggest retailer.
While analysts expect Tesco to report the steepest decline in domestic sales since at least 2005 tomorrow, they’re also the most optimistic they’ve been in at least two years on the company’s shares. Almost three-quarters say clients should buy - - advice Buffett’s Berkshire Hathaway Inc. already followed by raising its stake to 3.64 percent.
After four years of market-share erosion in the U.K., Tesco is fighting back. The retailer, which gets two-thirds of sales from its home market, last month unveiled the Big Price Drop campaign in a bid to win shoppers from rivals including Wal-Mart Stores Inc.’s Asda amid stagnant economic growth. Chief Executive Officer Philip Clarke also needs to eliminate U.S. losses, while exploiting growth in Asia and eastern Europe.
“There are a lot of good things going on at Tesco and I suspect that’s what Buffett has observed,” said Phil Doel, whose funds at F&C Asset Management own 0.8 percent of Tesco. Clarke, who succeeded Terry Leahy as CEO in March, “is gradually stamping his authority on the business.”
Tesco shares have risen 4 percent since the retailer announced its price campaign on Sept. 22, cutting this year’s drop to 13 percent and boosting its market value to 29.7 billion pounds. Berkshire Hathaway raised its stake from 3.21 percent, a person familiar with the matter said Sept. 26.
Retail sales fell in August for the first time in three months as U.K. inflation accelerated at twice the pace of wages, eroding spending power. In response, Tesco shaved 500 million pounds from the price of basic items such as milk and vegetables in a campaign funded by ending double rewards on its loyalty card and reducing costs in areas like supply-chain management.
“They don’t need to be the absolute cheapest on everything, but the offering needs to be seen to be good value, so this move is sensible,” Doel said.
Thirty of the 42 analysts monitored by Bloomberg, or 73 percent, have a “buy” recommendation on Tesco stock.
The consensus analyst recommendation on the shares is 4.27, according to Bloomberg data, with each recommendation ranked on a scale of 1 to 5. That’s the highest in at least two years and ranks above domestic competitors J Sainsbury Plc at 2.74 and William Morrison Supermarkets Plc at 3.74. Of Tesco’s three larger global rivals, Wal-Mart has a rating of 3.77, Carrefour SA 3.02 and Metro AG 4.02.
Tesco’s share of U.K. grocery spending fell to 30.4 percent in the 12 weeks through Sept. 4 from 30.8 percent a year earlier, according to Kantar Worldpanel research, as discounters Aldi and Lidl and the upmarket Waitrose chain gained ground.
The retailer will report first-half results tomorrow and may say that sales at stores open at least a year fell 0.8 percent excluding gasoline and value-added tax, according to the median of 12 estimates compiled by Bloomberg. That would be Tesco’s weakest domestic performance since it started regularly reporting revenue on that basis in 2005.
London-based Sainsbury may also say tomorrow that same- store sales rose 2 percent in the second quarter on a basis that includes VAT, according to the median of eight estimates.
Tesco sells more non-food merchandise such as televisions, clothes and appliances than competitors, leaving it vulnerable to reduced spending by consumers on non-discretionary items.
The retailer may report an increase in first-half earnings, driven by gains in the emerging markets of eastern Europe and Asia, as well as a reduced loss at the U.S. Fresh & Easy chain, analysts said. So-called trading profit probably rose 8 percent to 1.83 billion pounds, even as sales growth slowed in countries such as Ireland and Poland, according to the median estimate of 18 analysts surveyed by Bloomberg.
“Tesco has achieved much in the last 15 years through internationalization,” Shore Capital analyst Clive Black wrote before the results. “The worth of this diversification to the group’s investment case is never more apparent than now to our minds, with the U.K. seemingly in the doldrums.”
Black estimates Tesco’s first-half trading profit will gain 13 percent in Europe and 12 percent in Asia, while predicting a loss of 70 million pounds in the U.S., down from 95 million pounds a year earlier. The retailer is opening more Fresh & Easy stores in northern California and adding ready-made meals and fresh bakery items as it aims to break even in the U.S. by 2013.
“Sages like Warren Buffett recognize that Tesco is a global powerhouse, and not just dependent on the struggling U.K. consumer,” said Nick Bubb, an analyst at Arden Partners in London with an “add” recommendation on the shares.
© Copyright 2014 Bloomberg News. All rights reserved.