Tesco Has No Competitive Advantage, say Analysts

Equity analysts do not have enough confidence in Tesco's ability to sustain excess returns over the long term to assign the firm an economic moat

Ken Perkins 12 August, 2015 | 12:38PM
Facebook Twitter LinkedIn

We believe Tesco's (TSCO) scale allows the firm to operate more efficiently than many competitors, and its convenient locations and loyalty program should continue to drive traffic. However, we do not have enough confidence in Tesco's ability to sustain excess returns over the long term to assign the firm an economic moat.

Tesco does not have a material leg up on its peers

Switching costs are non-existent in grocery retail, and competing on price while sustaining excess returns is a tough proposition.

Moaty defensive retailers tend to have clear cost advantages, and because Tesco's competitors have sufficient scale to remain competitive on price while touting points of differentiation – many of which could be replicated over a decade, we don't think Tesco has a material leg up on its peers.

Tesco is the largest food retailer in the U.K., where it also sells gasoline and higher-margin general merchandise in multiple channels, including large-store formats, online, and convenience stores. The £170 billion U.K. grocery industry is highly consolidated, with Tesco’s market share at just less than 30%, Asda and Sainsbury’s have 17% each, and Morrisons with 11%.

The industry is very competitive, and rivalry has intensified over the past few years. Most firms spent the better part of the past decade increasing square footage to drive sales growth, but some of these investments failed to produce expected returns, particularly when the global economy slowed and consumers started spending more in alternative channels.

Tesco also operates more than 3,500 stores in Europe and Asia (30% of sales and profits). We think the firm remains well positioned in Korea, Malaysia, and Thailand, but results in other regions have been more challenging. The company recently decided to exit the U.S., where its Fresh & Easy concept failed to gain enough traction to support adequate returns on invested capital.

It also exited Japan in 2011, as deflationary pressures, cost-conscious consumers, and fierce competition weighed on profitability. China and India remain areas of opportunity, but achieving results comparable to those in the U.K. will be no small feat given regional market dynamics.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Tesco PLC308.90 GBX-0.13Rating

About Author

Ken Perkins  is a Morningstar equity analyst covering consumer packaged goods firms.

© Copyright 2024 Morningstar, Inc. All rights reserved.

Terms of Use        Privacy Policy        Modern Slavery Statement        Cookie Settings        Disclosures