Interactive Investor

Will Tesco profits warning be its last?

29th August 2014 11:37

Lee Wild from interactive investor

As we all know, Tesco is in deep trouble. In fact, things are so bad that new chief executive Dave Lewis will join the struggling supermarket on Monday, a month earlier than planned. And it's little wonder following a second profits warning in less than six weeks. Predictably, the dividend has been slashed, too, and the share price has slumped by another 9% to an 11-year low. The outlook is truly bleak.

Tesco now expects to make a trading profit of about £1.1 billion for the six months to 23 August, down from almost £1.6 billion a year ago. That will mean annual profit of just £2.4 billion to £2.5 billion. Tesco made £3.3 billion last year.

And in a further blow to shell-shocked shareholders, Tesco has taken a hatchet to the dividend, slashing the payout by 75% to a measly 1.16p per share. That alone should save the company over £280 million.

But that's clearly insufficient as Tesco needs extra firepower to bankroll a ferocious price war with the German budget supermarkets and domestic rivals. City estimates put the figure at between £1 billion and £1.5 billion. So the fallen food retailer has also stopped £400 million of capital expenditure, too, mainly on things like IT and its store refresh programme.

These decisions "have not been taken lightly," according to chairman Sir Richard Broadbent. But this is unlikely to be the panacea for Tesco's troubles. Consultant Howard Wheeldon agrees. "To my mind price and cuts in quality usually go hand in hand in retail so surely that cannot be the correct answer and response to Tesco's mountain of problems," he says. "And if consolidation is not to be an answer either then I rather suspect that cutting back on capacity may be the only suitable answer left."

This is clearly not the swansong outgoing chief executive Philip Clarke would have wanted, although he's been so savaged by both the City and financial press that it hardly matters. At least, now, former Unilever man Lewis will have had a month in the hot seat before presenting half-year results to the City on 1 October.

"The contrarian investor in me thinks that Tesco looks cheap, but investors will have to be prepared for the long haul as the turnaround won't happen overnight," says Interactive Investor's head of derivatives Mike McCudden.

Investment legend Warren Buffet retains a substantial stake in the food chain, too, but the Sage of Omaha's investment horizon can span a lifetime. Others may not be quite as patient, and our own stockpicker Edmond Jackson raised concerns last month.

And this second warning may not be the last. Latest data from researcher Kantar recently revealed Tesco's sales fell by 4% in the 12 weeks to August and its market share slumped by 200 basis points to 28.2%. It's also common for a new chief executive to do a "kitchen sink" job on arrival at a distressed company. Lewis will be "reviewing every aspect of the group's operations. This will include consideration of all options that create value for customers and shareholders." There's unlikely to be much respite for shareholders while Lewis draws up his masterplan.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.