Investors have somewhat fallen out of love with
Or are they? Credit rating agency Moody's has also lowered its opinion of the company, downgrading Tesco's credit rating from A3 to Baa1, citing increased competition and potentially lower margins. Should bond investors be concerned?
I would say probably not. It may well be true that the company's growth prospects have cooled, but we should view this in context. Tesco remains a large and highly profitable organisation (£3.8 billion for 2011) with relatively low levels of indebtedness (see last reports and accounts).
And while its core UK operation may be in need of some tender loving care, it is expanding in other areas - one of which is personal finance. Tesco Personal Finance issued bonds onto the London Stock Exchange's order book for retail bonds last year. Although Tesco's bank does not share the parent company's rating, the Tesco Personal Finance 5.2% Aug 2018 bond has traded lower over the last month (see blue line on chart). This perhaps echoes the negative sentiment seen in the equity and is a noticeable divergence from the range-trading behaviour of gilts.
It is also worth bearing in mind that the bank subsidiary has also released its own results (see link here). Profits are up 28.3 per cent and impairment levels are down. This suggests a good outlook for Tesco's bank, which is in the fortunate situation of being relatively new, and thus unencumbered with the type of balance-sheet horrors faced by its more established competition.
Most private investors prefer to buy their bonds at par or below. The Tesco Bank 5.2% August 2018 bond stands at 105.5 (mid-price), which works out as a yield to maturity (ie, including a small capital loss at redemption) of 4.2 per cent. That's still a premium, and this will dampen some of the demand. However, on a relative basis, the bond is good value. When launched, the bond offered an incremental yield of 2 per cent over gilts of an equivalent maturity. This spread has now widened to nearly 3 per cent, and I would expect the relationship to tighten back in over time.