Buffett Boosts Stake in Tesco

Britain's dominant supermarket chain Tesco PLC (TSCDY) has had, to say the least, some disappointing results as of late. Earlier this month the retailer posted weak seasonal figures that the CEO Philip Clarke described as "disappointing".

The company followed that up with its first profit warning in twenty years.

This Bloomberg Businessweek article points out earnings will "be around the low end of" consensus estimates and growth will be "minimal".

The fallout from all this was, unsurprisingly, a substantial decline in the shares of Tesco. Somewhat less expected was Warren Buffett's decision to add substantially to an already sizable position in the shares.

This Reuters article added that, according to a recent filing, Berkshire's position increased from 3.21% to 5.06% between January 12th and 13th. It was roughly a £500 million purchase based upon the closing share price.

The additional shares of Tesco should make the position among the top ten within the Berkshire Hathaway common stock portfolio.

It's hard to know whether an announcement like this is just the first of several shoes to drop. Was the recent profit warning just the first of many as they go about fixing some of the problems within their business?

At current levels of profitability Tesco is selling for roughly 10x earnings. So, on the surface, it seems reasonably valued. The 4% plus dividend seems well covered by current profit levels. The question is whether the current level of profitability remains relatively firm or not while the necessary adjustments to the business are made.

Tesco has industry leading operating profit margins (over 6% is certainly high for retail). Will those margins will be squeezed going forward as it spends money to fix supermarkets and otherwise improve its competitiveness?

The company admits it has issues with customer service and the quality/availability of goods in stores. They seem to have allowed store experience in its home market to become stale and dated while they were investing in overseas expansion. Tesco's overseas businesses have had relatively strong sales growth compared to the home market. With more than 5,300 stores in 14 countries its geographic footprint is considerable.

Last year, Buffett criticized the company for entering into the U.S. grocery market though, based upon his actions, he clearly remains a fan of Tesco's business overall.

Charlie Munger said Tesco's move into the U.S. market was "ill-advised".

"Tesco is God Almighty in England. But you come into southern California and you have Trader Joe's and Costco, that's tough competition," Munger said. "It's a different world."

Munger also jokingly said Tesco's Fresh & Easy U.S. grocery chain should be renamed "Fresh & Hard".

Tesco's record of consistent profitability is impressive. The company seems focused on making necessary changes that strengthen the franchise. That may turn out to be good news for shareholders in the long run if they can execute.

Still, it's not all that easy to gauge how long it will take for the needed changes to have an impact. Nor is it clear whether the cost of these changes will end up altering operating margins and ultimately the company's valuation.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.