Tesco Recommended

I saw this report from a Motley Fool Advisor, Zarr Pacificador on Daily Report and it covers most of my logic for Tesco as a buy. What it misses is Tesco's reduced vulnerability due to its global footprint that shelters Tesco from individual country downturns, and Tesco's capability to upset the UK banking sector by becoming a high street bank competitor.



A look at Tesco
Today I'm evaluating Tesco (ISE: TSCO.L) , a U.K.-based multinational retailer that also engages in general merchandise, telecom, banking and insurance services, which currently trades at 346 pence. Here are my thoughts:

1. Financial strength: Tesco has relatively modest gearing with net debt of 52% of tangible equity. The balance sheet is solid, backed up by property assets worth 36 billion pounds and interest cover of 15. I do not foresee any problems with liquidity as free cash flow generation has been strong -- averaging 2.5 billion pounds the past three years -- and will only improve with the company's intention to decrease capital expenditures and keep it below 5% of sales the next few years.

2. Profitability: Tesco's performance this past decade has been impressive, consistently delivering ROEs of 16%, compounding sales by 10% and earnings by 12% annually, while keeping operating margins at 6%. For the past five years, international sales and operating profits have grown by 14% and 8% per annum, respectively. Also, the company's online retail business has been highly successful, with Tesco now the world's largest and most profitable online grocer with revenues of well over 2 billion pounds. Moreover, the company has profited from its strategy of releasing the value of its property portfolio, gradually selling off property assets the last few years.

3. Management: After 14 years, CEO Terry Leahy has stepped down and has been replaced by Philip Clarke on March 2011. Admittedly, Leahy will be a tough act to follow -- during his tenure, sales have more than doubled and earnings have tripled, while the business has expanded into 13 countries, in the process becoming the world's third largest retailer. Nevertheless, Philip Clarke appears to be an able replacement -- he has been with Tesco for 36 years and was a huge part in the company's expansion into the international market.

4. Long-term prospects: Despite its recent struggles, Tesco still leads the U.K. with a market share of 30%, followed by Wal-Mart's ASDA on 17%, Sainsbury's 16%, andWilliam Morrison's 12%. It has invested 1 billion pounds to revitalize U.K. operations, while its international business has been growing rapidly and now accounts for 32% of revenues. In fact, the company has managed to become the leader in most of its markets outside the U.K.

5. Valuation: Tesco's current market cap of 28 billion pounds is significantly lower than the current market value of its properties pegged at 36 billion pounds. Its forward price-to-earnings ratio of 10 is at the lower end of its 10-year historical P/E ratio, and it currently gives an attractive dividend yield of 4.39%.

My verdict on Tesco
Although past performance is not indicative of future results, I believe Tesco can duplicate last decade's performance. Its fundamentals remain solid despite recent struggles in the U.K., while its international operations, burgeoning general merchandise and retail services -- banking, telecom and online store -- and property development strategy provide huge growth potential. Furthermore, the market value of its properties provides a significant margin of safety while its stable dividend yield, which has been growing by 10% for the past 10 years by the way, will reward investors while waiting.

So overall, I believe Tesco at 346 pence looks like a buy.