The United Kingdom's version of Wal-Mart (WMT 0.46%) is Tesco (TSCD.Y -0.64%). It's a retail giant with a highly diverse line of business -- recently the company has even entered the tablet game with its own version, the Hudl. In this week's earnings report, investors ran from ugly headline numbers, but eventually came back with hats in hands as the company shows some signs of improvements. Tesco has had its fair share of missteps, and then some, but it remains one of the most intriguing companies to follow in Europe. Let's take a closer look at the recent performance from one of Warren Buffett's high-conviction picks.
Earnings recap
In previous quarters, Tesco saw operations erode in China and the United States (the company has since pulled out of its U.S. venture, Fresh & Easy, and taken a $1 billion write-off), and for this quarter the disaster zone was in Central Europe. Profits slid 70% in the region, aided by a 20 million pound investment in Poland, which a Tesco finance director said would not lift results immediately.
While the initial market reaction was a sell-off, the stock recovered as earnings were digested. For a company that has failed to gain the trust of the market and investors in recent years, the sign of another region going downhill signals fire. At the same time, a stabilizing region could be cause for celebration. Back home in the U.K., Tesco saw things stabilize.
Domestic same-store sales were flat for the quarter when compared to the prior year, but certainly an improvement from the 1% decline in the previous quarter.
With a comfortable profit margin at its U.K. locations and a turnaround that has wisely involved shedding some international assets in favor of capitalizing on its incredible 30% market share in its home country, Tesco isn't wowing the market with quickly improving earnings. Valuation reflects this, and should intrigue investors who believe in the fundamentals that make this company a favorite of the Oracle of Omaha.
Priced for "meh"
Tesco trades at less than 10.5 times forward earnings. For giant retailer comparison, take a look at Wal-Mart at 12.79 times. Wal-Mart is the easy comp here and should interest investors because, even though it also has had issues lately with keeping sales up, the market isn't too concerned. Wall Street's faith in Wal-Mart is largely unrattled, whereas in the U.K., the City seems to think Tesco will remain a tepid performer -- at best.
In recent years, Tesco has had to adjust to discount supermarkets and high-end players eating both ends of its market share. With the situation seemingly stabilizing at home, the company should be able to show investors that, over the long term, Tesco can still leverage its tremendous footprint and maintain its powerhouse position. The U.S. and Chinese operations are going into the rearview mirror (with the exception of a joint venture with China Resources Enterprise), and those losses have already had their impact on the company. There is also speculation that the company may exit its Turkish operations, which have failed to produce much good.
As the poorer decisions are weeded out, the better ones will start to carry more weight on financial statements in coming years. One recent victory has been the Hudl tablet -- selling 35,000 units in its first two days on the market.
Tesco's turnaround is still nascent, but more important is that the fundamentals remain intact. Tesco is one amazing retailer, and as a long-term investment, its merits outweigh short-term difficulties.
