The 3 Biggest Risks Facing Tesco

LONDON -- Supermarket giant Tesco (LSE: TSCO.L  ) (NASDAQOTH: TSCDY) is a business with clear attractions. A 26 billion pound FTSE 100 constituent, the company is expected this year to deliver revenue of 67 billion pounds and pre-tax profit of 2.6 billion pounds.

Better still, Tesco is attractively priced: With its shares changing hands today at 322 pence, the company is rated on a prospective P/E of just more than nine and offers a forecast dividend yield of 4.8%.

But how safe is that share price? And -- of critical importance for income investors -- how safe is that dividend? In short, how could an investment in Tesco adversely impact investors' wealth?

In this series, I set out to answer just these questions. My starting point: Tesco's latest annual report, where the company's directors are obliged to address the issue of risk.

Risk management
One immediate thing I'm looking for is an acknowledgement that risks do exist and that they need managing.

The good news? As you'd expect from a business of Tesco's size and caliber, the company has in place a risk management policy, a system of regular reviews, and a number of high-level committees tasked with monitoring the risks that the business has identified.

But what, precisely, are these risks?

Read the small print, and Tesco identifies no fewer than 22 risks as having a significant prospective impact on the company's financial performance. They range from competition to IT systems and from product safety to terrorism.

So let's take a look at three of the biggest risks -- in this case, three that Tesco says have actually increased since 2011.

Performance risk
As we've seen in recent months, Tesco is under pressure because of flagging sales growth. As the company says: "There is a risk that business units (including the UK) underperform against plan, and against competitors, and our business fails to meet the stated strategy in full. Like all retailers, the business is susceptible to economic downturn affecting consumer spending."

What is the company doing in response? First, clear goals and objectives are set for subsidiary CEOs, with a high proportion of reward based on achievement. Second, the board, executive committee, and various operational committees meet regularly to review performance risks, while performance against budgets and KPIs is monitored continually.

Reputational risk
Tesco's brand is huge, covering groceries, furniture, electrical goods, catalog sales, and financial services. The downside of this? As the company puts it, "Failure to protect the Group's reputation and brand could lead to a loss of trust and confidence, a decline in customer base and affect our ability to recruit and retain good people."

How does the company address this risk? In various ways. First, a set of "Tesco Values" is embedded the company's business practices at every level, with specific governance committees guiding and monitoring policies. Secondly, there's regular stakeholder communication and engagement to understand stakeholders' views and reflect them in the company's strategy.

Economic and political risks
Clearly, the state of the economy has a big impact on people's spending power. Political risks are an issue, too: New laws in Korea, for instance, mean that the company's Korean Homeplus stores can no longer be open around the clock and must also shut for two Sundays a month -- instantly hitting this year's profit by 100 million pounds. As Tesco notes: "In each country where we operate, we may be affected by legal, regulatory and tax changes, increased scrutiny by competition authorities, political developments and the economic environment."

How are such risks dealt with? Broadly speaking, says the company, "external uncertainties are carefully considered when developing strategy and reviewing performance; we try to anticipate and contribute to important changes in public policy wherever we operate, and business development follows thorough due diligence work."

Risk vs. reward
Two superstar investors who are used to weighing risks are Neil Woodford and Warren Buffett.

On a dividend-reinvested basis over the 15 years to the end of 2011, Neil Woodford delivered a return of 347%, versus the FTSE All‑Share's distinctly more modest 42% performance. Warren Buffett, for his part, has delivered returns of more than 20% per annum since 1965, making himself the world's third-wealthiest person.

Each, as it happens, is the subject of a special report prepared by Motley Fool analysts. And these reports are yours to download without any obligation. So click here to download this free special report profiling the investment logic behind eight of Woodford's largest and most successful current picks. And click here to discover which beaten-down British share Warren Buffett has been buying of late -- as well as why he bought it and the price he paid.

Malcolm owns shares in Tesco. The Motley Fool owns shares in Tesco. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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