Tesco Corporation (USA) (NASDAQ:TESO), the UK retailer, is a core holding of Buffett’s Berkshire Hathaway Inc. (NYSE:BRK-B). Warren Buffett initiated his stake in Tesco in 2006 and has gradually added to his position since. In early 2012, a filing indicated a significant increase in the position from 3.21% to 5.08%. This stock was the worst performing major holding of Buffett in 2012 and is down by 5% since Jan. 6, 2012 – FTSE 100 up 17.17% over the same time frame. However, since mid-November 2012 the stock has steadily increased and could be positioned for a strong performance in 2013.
Tesco Corporation (USA) (NASDAQ:TESO) is an international retailer based in the United Kingdom. UK sales contribute around two-thirds of sales. It also has international operations in China, the Czech Republic, Hungary, Ireland, India, Malaysia, Poland, Slovakia, South Korea, Thailand, Turkey and the United State. It is essentially the UK version of Wal-Mart Stores, Inc. (NYSE:WMT) andTarget Corporation (NYSE:TGT) with in store opticians, pharmacies, phone shops and restaurants. It is the world’s third largest retailer. Wal-Mart Stores, Inc. (NYSE:WMT) has a massive $469 billion in sales while Target Corporation (NYSE:TGT) has $73 billion, and Tesco has $65 billion. Out of these retailing behemoths, Wal-Mart Stores, Inc. (NYSE:WMT) has has the highest ROA and Tesco currently has the lowest. While Tesco operates across various geographies and has a diverse product offering, its core business remains the UK grocery business. The stock tracks most closely to movements in this market.
Tesco is the largest grocery retailer in the UK. Tesco Corporation (USA) (NASDAQ:TESO)’s operating margin of 6.2% is above that of UK grocery competitors J Sainsbury plc (LSE: SBRY) and Wm Morrison Supermarkets. Sainsbury’s operating margin is at 3.98%. It has also initiated a price matching initiative that will issue customers a voucher if the price paid would have been lower at Morrisons, Sainsbury’s or Asda.
There are some key challenges for Tesco Corporation (USA) (NASDAQ:TESO). First, it is one of the stores in the UK in the midst of a horsemeat scandal that likely led to the slight decline in grocery sales reported in the most recent industry data. The issue is probably temporary and it will push through this as it did not knowingly sell horsemeat. Second, conditions in mainland Europe remain difficult and growth is likely to slow from the 8% CAGR since 2008. It will also likely have to slow opening new locations in Asia, muting growth expectations due to issues there. Positively, this will contribute to the lower capex forecasts and improved FCF.
Renewed focus on FCF
Management has undertaken a restructuring of the company over the past few years. The CEO appointed and managing director of its UK operations, a new position, that will allow him greater focus on European and challenged operations in the rest of the world. Tesco Corporation (USA) (NASDAQ:TESO)’s core business has started to stabilize and it is exiting the US and Japan, where its effort to penetrate these markets were unsuccessful. Expectations are for a decline in capex over the coming years with less focus on square footage growth and more on improving same store sales. It is in the midst of a remodeling/refreshing its stores in the UK in order to accomplish this. The change in focus should lead to increased free cash flow generation and ability to return cash to shareholders via dividends and repurchases. Along these lines, Tesco has increased its dividend for 28 consecutive years.
Conclusion
Tesco Corporation (USA) (NASDAQ:TESO) is worth further investigation and possibly positioned to outperform in 2013. Its UK operations are improving, news flow on its international front will not likely get worse and FCF is expected to improve leading to increased dividends and share repurchases in the near-term. This company could look better for Berkshire this year.
The article Repositioning Should Help Buffett’s Worst Major Holding of 2012 originally appeared on Fool.com and is written by Mike Thiessen.
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