- Tesco has a strong market position
- The company has robust cash flows
- It is accelerating its cost-saving programme
James de Uphaugh, manager of Edinburgh Investment Trust (EDIN), explains why he invests in Tesco (TSCO).
"Tesco's market-leading position was enhanced during the pandemic and it enters a much tougher phase for the UK economy on the front foot. The grinding consistency of its Aldi price match campaign and its unique Clubcard offer have driven gradual market share gains for Tesco over the past three years.
"Tesco's previous chief executive officer, Dave Lewis, put a lot of work into rehabilitating relationships with suppliers and this work continues, with Tesco ranked number one in the Advantage Survey – the Oscars equivalent for suppliers. This has put Tesco in a good position to cope with the current reality. Suppliers have been facing major input price increases and been looking to raise prices. Tesco has the data to know which price rises are justified and which are not, and plays hardball when they’re not – as recent stand-offs with Heinz and Colgate showed. The net result is that Tesco's price file has inflated a little less than the industry, according to data from The Grocer magazine, and Tesco has often moved prices up later than the industry.
"This dynamic [has helped it build] its strong market position. Asda and Morrison, two of the big four UK supermarkets, are saddled with buy-out levels of debt that constrain their room for manoeuvre, with Morrison in particular haemorrhaging volumes. The limited range discounters, meanwhile, are strong competition with advantaged business models, low wage-to-sale ratios and relatively efficient stores from an energy perspective. But Tesco's Aldi price match blunts the competitive position to a degree, and both Aldi and Lidl, which report results with a distinct lag because they are private companies, have skinny current profit and loss metrics which often mean they raise prices first.
"Tesco is likely to navigate supplier-driven cost increases but, in common with the industry, costs relating to wages and energy are of a quantum that it is more difficult to offset. However, Tesco is accelerating its cost-saving programme to mitigate this.
"And the uncertain path of the UK economy has thrown up an opportunity to buy this market leader at remarkable valuation metrics."
Tesco was Edinburgh Investment Trust's fourth-largest holding, accounting for 4.8 per cent of its assets at the end of August. Investors' Chronicle rates Tesco as a 'Buy' for reasons including a higher free cash flow forecast and strong market share.
