Tesco Analysis - Case Study Example

Executive Summary

Tesco Plc. has a long history of success in the UK retail sector. It overtook the leading position in the market by devising a low price strategy that was difficult for other companies to replicate. The low price strategy not only generated huge profits for the company but also convinced the company’s management to take the company to the international markets. The company successfully achieved this when it expanded in similar European markets and emerging markets in Asia. However, it was struck by a major venture failure in the U.S. Drawn by the lust to enter the huge U.S. market, the management lost its focus on the company’s primary UK market. The lack of focus or interest in the UK market led to a series of wrong decisions and performance short of expectation of consumers. The delay in decision-making and ability of other companies to replicate its low price strategy put the company on the back foot. Although the company still holds the largest market share, its position is weakening.

The company’s financials clearly indicate the poor performance of business as sales and net profit showed a declining trend in the last five years. In 2015, the company reported a net loss that has almost eradicated its retained earnings. The company increased its debt level significantly and it reported total borrowing of £12.6 billion. The company can face problems meeting its high finance costs and pay dividends to its shareholders.

The company’s stock value is on a decline and if the company’s management to devise and implement effective strategies in the coming years then there could be further losses for the company and closure of its stores.

Introduction

Tesco Plc. (Tesco) is one of the leading UK based retail companies. The company was formed in 1919 and its head office is located in Cheshunt, UK. The company became a public limited company in 1983. Its main business is grocery retailing and it also provides financial services including banking and insurance services. The company has various subsidiaries that perform different business activities. It has7,817 stores operating in eleven markets including the UK and countries across Europe and Asia.

The company remained as the leading brand for many years. However, in the recent years, the company faced major setbacks as it attempted to make entry into the U.S. The company’s management was criticized for lacking focus on its primary UK market that allowed other retailers such as Aldi, Morrison, and Sainsbury’s to take advantage and gain market that was once controlled by Tesco.

After roll back of its venture in the U.S. the company has reverted its focus on the UK market. However, it appears that the company did not realize the challenges that it faced in this market and ignored the changing needs and requirements. The company’s reputation was long vested in its low price strategy and it generated huge profits for the company for many years. Other companies have replicated the low price strategy and Tesco has lost its edge over its competitors. Moreover, other retailers have focused on strategies to address customer issues and improve customer experience in their stores. The trends in the UK consumer market reflect preference of shopping through e-commerce websites. Tesco did not invest sufficient resources in the improvement of its website and offerings it made to customers as compared to other companies.

As the company diverted its strategy to global expansion, its relationships with suppliers and customers in the UK market became weak. Major criticism was regarding the leadership that did not focus of improving customers’ experience, investing in its UK stores and increasing investment in alternate channels of selling during 2011 and 2012. The company also suffered from weak oversight that resulted in a fraud scandal based on misreporting of profits .

The five-year financial record clearly indicates that the company’s management has failed to take initiatives that could reverse the company’s ailing conditions. The company incurred a net loss of £5,792 million in 2015. Furthermore, it could be noted that the finance cost of the company had been increasing every year that indicated the company relied heavily on external debt to fulfill its business needs. The increasing depending on external borrowing could lead to liquidity and solvency problems for the company as it may fail to pay interests if it continues to make operating loss. The company’s short-term and long-term borrowing reached $12.659 billion in 2015 with an additional borrowed amount of £1.446 billion.

Capital Structure

The review of the company’s balance sheet for the year ending 2015 and 2014.

28-Feb-15

22-Feb-14

£m

£m

Retained earnings

1,985

9,728

Debt

Short Term Borrowing

2,008

1,910

Long Term Borrowing

10,651

9,303

Total Debt

12,659

11,213

Common Shares

Number of Shares

8,107

million

Market Price

1.495

per share

Market Capitalization

£12,120

million

Equity

The following table provides details of the total shareholders’ equity as of 28 February 2015. It could be indicated the company’s equity position declined by 52%.

Equity

£m

£m

Share capital

406

405

Share premium

5,094

5,080

All other reserves

(414)

(498)

Retained earnings

1,985

9,728

Equity attributable to owners of the parent

7,071

14,715

Non-controlling interests

–

7

Total equity

7,071

14,722

Source:

The company’s cost of equity is calculated in the following.

Using CAPM

Re =

Rf+β(Rm-Rf)

Rf =

4%

β =

0.7826

Rm =

10%

Re =

4%+0.7826*(10%-4%)

Re =

8.70%

The beta value of 0.7826 is less than 1 that implies that the stock price of Tesco is less sensitive to changes in the market index. The monthly return on the company’s return and market index indicate that both move in the same direction but the stock price is not volatile. The poor performance of Tesco is the reason for the decline in its stock price. However, it could be observed that the UK retail sector has been sluggish and companies are not able to increase consumer spending that had been affected by the recent financial crisis and it is expected to perform at a lower growth rate than previous years. Some of the factors that contribute to the growth of the UK retail sector include exports and growth in the housing sector. Based on the assumption that the return on market is 10% and the risk free rate is 4%, it is estimated that the cost of equity of Tesco is 8.70% that will be expected by shareholders on their investment in the company. However, the company generated a loss in 2015 and it could become difficult for the company to retain trust of shareholders in its stock. It is further suggested that if the company’s management fails to turn around the company, there could be withdrawal of shareholders’ investment.

Debt

The balance sheet of Tesco indicated that the carrying value of debt was £12.659 billion in 2015 .

Based on the last reported financial statements of Tesco, it could be determined that Debt/Equity ratio of the company had values of 1.79 and 0.76 in 2015 and 2014 respectively. It implies that the company relied heavily of external borrowing and it is highly indebted. The decision of Tesco to borrow additional funds to be repaid in short, medium, and long terms (See Appendix: Medium to Long Term Funding) could be related to the Pecking Order Theory of capital structure decisions. The company had long enjoyed high profits and had substantial equity as retained earnings. It funded most of its business requirements through internal equity. However, as the company started to face financial problems in terms of sales generation and ability to record profit from operations, it has increased its borrowing. It is clear from the review of the company’s financial statement that it has added borrowing of £1.446 billion in 2015 when the company’s retained earnings were just £1.985 billion (2014: £9.728 billion). The company has almost depleted its retained earnings and had to borrow from external sources to fund its strategic, operation, and tactical plans.

Share Price Analysis

Tesco faced major financial problems in the last five years. A slowdown in the company’s business and poor strategic outcomes are the primary reasons for the decline in the stock price of Tesco. The figure below depicts a sharp dip in the company’s stock price in 2013-14 and the general declining trend continued in 2014 and 2015. The company’s inability to generate profits and higher leveraged position continue to post risks for further decline in the stock’s value. The figure also indicates that the stock price of Tesco’s competitor company i.e. Sainsbury’s Plc. showed stability in its value. There were simpler dips in its value but the trend shows Sainsbury’s stock was able to stabilize after making good strategic decisions.

The figure provided below depicts monthly return on stock of Tesco’s and Sainsbury’s along with the return on FTSE 100 Index.

The table below indicated 5-year of Tesco, Sainsbury’s and FTSE 100 Index. Both Tesco and Sainsbury’s stocks underperformed as compared to FTSE 100 that had a return of 6.47%. The stock value of Tesco generated a negative return of almost 56% on holding the company’s stocks for five years.

5-Year Return

Price Dec 15

Price Jan 2011

Change £

Return %

Tesco Plc.

149.5

339.57

-190.07

-55.97%

Sainsbury's Plc.

258.8

297.44

-38.64

-12.99%

FTSE 100 Index

6,242.30

5862.9

379.4

6.47%

Medium Term Notes (MTNs)

Interest Rate Supplement

Principal Outstanding

Currency

Maturity

4.00%

200m

GBP

2016

5.88%

1.039bn

EUR

2016

5.50%

850m

USD

2017

2.70%

500m

USD

2017

1.25%

500m

EUR

2017

3.38%

750m

EUR

2018

5.50%

350m

GBP

2019

1.38%

1.25bn

EUR

2019

2.13%

500m

EUR

2020

6.13%

900m

GBP

2022

5.00%

389m

GBP

2023

2.50%

750m

EUR

2024

3.32%

210m

GBP

2025

6.00%

200m

GBP

2029

5.50%

200m

GBP

2033

1.98%

196m

GBP

2036

6.15%

1.15bn

USD

2037

4.88%

173m

GBP

2042

5.13%

600m

EUR

2047

5.20%

279m

GBP

2057

Short Term

2bn

GBP

4bn

USD

Revolving Credit

2.6bn

GBP

2019

Source:

Appendix: Monthly Value of Stocks and Index

Month

Tesco Adj Close

Sainsbury's Adj Close

FTSE 100 Adj Close

Month

Tesco Adj Close

Sainsbury's Adj Close

FTSE 100 Adj Close

Month

Tesco Adj Close

Sainsbury's Adj Close

FTSE 100 Adj Close

Dec-15

149.5

258.8

6,242.30

Dec-13

321.02

329.51

6,749.10

Dec-11

353.87

248.5

5,572.30

Nov-15

167.2

253.8

6,356.10

Nov-13

334.08

367.79

6,650.60

Nov-11

355.41

249.4

5,505.40

Oct-15

183.3

262.2

6,361.10

Oct-13

349.68

351.81

6,731.40

Oct-11

352.38

241.36

5,544.20

Sep-15

183.2

256.88

6,061.60

Sep-13

340.26

349.14

6,462.20

Sep-11

327.78

221.75

5,128.50

Aug-15

191.35

238.87

6,247.90

Aug-13

347.42

342.99

6,412.90

Aug-11

328.3

242.01

5,394.50

Jul-15

215.7

260.72

6,696.30

Jul-13

348.13

351.01

6,621.10

Jul-11

332.5

245.4

5,815.20

Jun-15

212.55

261.12

6,521.00

Jun-13

314.1

316.86

6,215.50

Jun-11

348.59

265.81

5,945.70

May-15

212.6

247.63

6,984.40

May-13

346.37

333.8

6,583.10

May-11

363.38

278.89

5,990.00

Apr-15

221

259.84

6,960.60

Apr-13

347.04

329.5

6,430.10

Apr-11

349.93

271.56

6,069.90

Mar-15

241.85

247.52

6,773.00

Mar-13

351.83

327.25

6,411.70

Mar-11

321.27

261.42

5,908.80

Feb-15

245.4

259.65

6,946.70

Feb-13

340.81

298.98

6,360.80

Feb-11

340.84

296.27

5,994.00

Jan-15

224.75

243.89

6,749.40

Jan-13

328.55

285.93

6,276.90

Jan-11

339.57

297.44

5,862.90

Dec-14

189

235.58

6,566.10

Dec-12

309.83

298.38

5,897.80

Nov-14

186.45

222.88

6,722.60

Nov-12

299.78

295.18

5,866.80

Oct-14

173.6

229.97

6,546.50

Oct-12

294.94

302.17

5,782.70

Sep-14

184.95

235.59

6,622.70

Sep-12

301.64

296.12

5,742.10

Aug-14

228.41

271.94

6,819.80

Aug-12

305.81

279.16

5,711.50

Jul-14

256.27

293.11

6,730.10

Jul-12

289.01

275.5

5,635.30

Jun-14

282.3

295.55

6,743.90

Jun-12

281.69

256.83

5,571.20

May-14

301.52

324.21

6,844.50

May-12

274.88

245.5

5,320.90

Apr-14

290.99

303.06

6,780.00

Apr-12

288.33

252.6

5,737.80

Mar-14

283.62

285.36

6,598.40

Mar-12

289.45

255.39

5,768.50

Feb-14

316.08

309.29

6,809.70

Feb-12

277.26

244.72

5,871.50

Jan-14

307.58

311.36

6,510.40

Jan-12

280.33

236.6

5,681.60

Source: (Yahoo! Finance, 2016c; Yahoo! Finance, 2016b; Yahoo! Finance, 2016a)