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Tesco's troubles split funds seeking oversold stocks

A woman walks past a Tesco supermarket in central London, December 9, 2014. REUTERS/Toby Melville

By Simon Jessop and Nishant Kumar

LONDON (Reuters) - A halving of Tesco's (TSCO.L) share price is luring only the boldest active fund managers back into Britain's top supermarket group, with many still unpersuaded it can recover from a year of disasters.

While still Britain's biggest grocer by far, Tesco's days of achieving startling growth appear to be over. However, some fund managers tasked with hunting out cheap stocks ripe for a rebound are taking the plunge.

Doubters, on the other hand, argue that Tesco has yet to become a value stock, attractive for its price as much as its business growth prospects.

Tesco has issued a string of profit warnings as low-cost rivals eat into its business. Its problems deepened in September when it admitted to overstating earnings, prompting a series of investigations including by Britain's Serious Fraud Office (SFO) and leading to a fourth lowering of profit forecasts on Tuesday.

Many shareholders have bailed out during the 53 percent slide in Tesco stock since the start of the year, including legendary U.S. investor Warren Buffett. Concerns also remain about the company's governance and strategy.

Index tracker funds, which have no choice but to buy constituent stocks as investors give them money, remain among the biggest buyers of Tesco shares.

However, some active "value" funds, which seek oversold stocks, have also bought in as Tesco has shuffled its management and prepares to announce a strategic plan in January.

To them, Tesco already looks cheap. Its market value has lost 12.8 billion pounds ($20 billion) this year and the shares trade at 0.9 times the forecast value of its assets over the next 12 months, 53 percent below its 10-year median.

On another measure, Tesco stock trades at 1.1 times its current book value compared with the 1.4 times average for leading European supermarket groups.

Ian Kelly, a fund manager in the value investing team at Schroders, said the share price was justified only if the group were to suffer from a combination of three negative factors.

"Its current valuation implies the present tough environment lasts forever, that most supermarkets will make no money and Tesco will never grow its revenues again," he said. "To us, this seems like an unlikely triad of circumstances."

Kelly cited Tesco's robust balance sheet and its size: it had a 28.9 percent share of the UK market at mid-year compared with 17.1 percent for second placed Asda. Schroders added 30 million shares, a Nov. 18 filing showed, to make it Tesco's eighth-biggest shareholder.

Keeping track of who owns a stock at any given moment is hard as funds typically disclose full holdings publicly only every three or six months, but data from tracker Morningstar shows the divergent opinions among all funds.

Just over a quarter of the 151 British funds disclosing their bets on Tesco between September and November raised their exposure, Morningstar data showed. Slightly more than a fifth cut their exposure, while the rest made no changes.

Norway's oil fund, the top shareholder with nearly 7 percent, said in October that Tesco had weighed on its performance. However, it refused to say whether it had sold out, and is not expected to update the market until March 2015.

BlackRock (BLK.N) and Legal & General (LGEN.L), the second and third biggest shareholders, added to their positions, filings in November showed, but much of this was through index tracker funds.


Geir Lode, Head of Hermes Global Equities, believes it is too early to buy into Tesco, saying he sees no sign yet that it can fight off attacks from low-cost rivals Lidl and Aldi.

"Further, the share price faces short term pressures: the SFO’s investigation and an almost inevitable downgrade of its debt to junk status," he said. "We think that it is premature to own the stock."

Speculators, however, do not appear to be borrowing Tesco stock heavily to sell it short in the hope of a further slide. Only about 3 percent of Tesco shares that can be borrowed are out on loan on Dec. 9, compared with over 6 percent for all constituents of the FTSE 100 index, Markit data showed.

As Tesco shares have dived, so have expectations of its earnings. They now trade at 11.5 times expected earnings over the next 12 months, only 4 percent below its 10-year median, Thomson Reuters data showed. Analysts have cut their earnings estimates by 54 percent this year.

Elsewhere among Tesco's top-10 shareholders, value-focused firm Silchester International Investors added 4 million shares to take its stake to 2.48 percent, October filing data showed.

U.S.-based Artisan Partners - the fourth-biggest shareholder with a 2.54 percent stake after buying 32 million shares, a filing on Nov. 18 showed - added more than 11 million shares to its International Value Fund alone.

Among those bailing out are Harris Associates, which shed two thirds of its stake, 143 million shares, an Oct. 15 filing showed. It has declined to comment about the sale.

Questions remain about Tesco's ability to keep paying its dividend and the strategic review. A source in charge of stock-picking at one of the world's biggest money managers with many value funds said he was waiting due to the high uncertainty.

"It has some very good assets that it can sell and I don't think debt is a massive problem. But markets will be focusing on what is the cash generation of this company. Has that changed?"

(Additional reporting by James Davey; editing by David Stamp)