There’s no doubt that Tesco (LSE: TSCO) is a leaner, fitter operator than it’s been for some years, and its share price reflects that with a gain of 19% over the past 12 months (compared to a 6.5% drop in the FTSE 100).
But that comes after 2018’s earlier optimism has started to fade, culminating in an 8.5% share price dip on the day of the supermarket giant’s interim results on 3 October.
Tesco reported generally positive figures across the board, with sales up 12.8%. And a 67% hike in the interim dividend, while taking it to only a modest 1.67p per share, is a move in the right direction.
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Margins tight
But operating profit didn’t sparkle, falling by 6.5% in reported terms, and by 1.4% on a “retail operating cash flow” basis. That’s important to me, as it puts the focus where it needs to be — on the fact that this is a very low margin business, whatever margins chief executive Dave Lewis is aiming for.
It’s also reinforced by the opening of Tesco’s new cut-price chain Jack’s, named after company founder Sir Jack Cohen, which aims to compete head on with Lidl and Aldi. But for me, that raises a couple of questions. Why can’t Tesco just compete with them anyway? And why has it taken so long to address the only thing that really matters in the groceries business?
That brings me to why I just wouldn’t buy supermarket shares, whether it’s Tesco, Sainsbury, or Morrisons (or even Aldi or Lidl, if they were available).
Poor differentiation
I see the groceries business as a fine example of economic efficiency. It’s occupied by a number of players of various sizes, all offering essentially the same interchangeable goods with little or no real differentiation — it matters nothing to me what label is on a can of whatever I’m buying, and that’s increasingly the case with hard-pressed shoppers.
And, with a few exceptions, they are increasingly competing only on price. Even Sainsbury, which has long prided itself on offering a slightly upmarket service, is aiming for a merger with Asda to help get prices down.
Competitive advantage
But while it’s great for consumers, an economically efficient market is perhaps not what investors should do best from. What we should prefer, surely, is a market with significant product differentiation and with clear defensive positions — the kinds of things that provide the best companies with significant market advantage over their competitors, and so support higher margins.
It’s also largely why I’ve never invested in airlines. In the most part, they offer exactly the same service and compete only on price. I know some, like easyJet, have done very well — but in the decades I’ve been investing, very few have really been big successes.
Time will tell
Tesco’s recent progress has been looking good now that it has been doing the big things — the purchase of Booker Group wholesaler was a particularly canny move, I reckon. But it’s the small things over the coming years that will matter, the day-to-day competition on price.
And on that score, I don’t see any significant attraction in Tesco over anyone else.
