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Buffett cuts Tesco stake: should you do the same?

Joanna Faith
Written By:
Joanna Faith
Posted:
Updated:
24/10/2013

As one of the most hotly observed stock pickers in the world, Warren Buffett’s decision to cut his stake in Tesco received a lot of attention in investment circles this week.

According to stock market filings, Buffett’s firm Berkshire Hathaway, a Tesco shareholder since 2006, cut its holding to 3.98% from 4.98% on 16 October.

While Berkshire has not elaborated on the reasons behind the decision, the news has been widely linked to Tesco’s recent 68% decline in profit earnings from mainland Europe for the first half of the year and its failed attempts to break into the US, Japanese and Chinese markets.

The big question for Tesco investors is whether they should follow the venerable Buffett or stick with the supermarket giant.

The first point to note is that Buffett has not sold out of Tesco completely. He has famously been quoted as saying: “If you get into a lousy business, get out of it.” So, by simply cutting his stake it is clear he has not thrown in the towel altogether.

However, the move does suggest there is some cause for concern.

“It shows he is disappointed that management has so far failed to deliver improvement since last year’s profit warning,” according to Garry White, chief investment commentator at Charles Stanley.

“However, the supermarket’s board can take heart that Tesco remains one of Berkshire Hathaway’s biggest investments outside the US.”

One big negative for Tesco is it faces intense pressure from a highly competitive and increasingly polarised UK market.

Its market share grew by just 0.4% over the past year, according to figures released this week from research group Kantar. In comparison, Sainsbury’s grew by 3.7%.

Discount retailers fared even better, although they still remain small players. Aldi’s market share is just 3.8% but it has grown 31.7%. Lidl has 3% of the market, up 13% in only 12 months.

“Competing with these two rivals could mean deep discounts and lower margins, something investors will not want to see,” says White.

Yet there are reasons to be positive. Nicla Di Palma, equity analyst at Brewin Dolphin, says food volumes, which have been declining steadily since 2008, will start increasing in the UK from next year.

“Volumes have been declining for five years in a row as consumers reduced waste,” she says.

“While I don’t think people will suddenly start buying food and throwing it away when they don’t get around to eating it, population is increasing. The fall in volumes is unsustainable.”

She also expects to see an improvement in the UK business following a revamp of both stores and products. For example, the new Tesco Finest range was launched two weeks ago which saw the introduction of 400 new products. After that, she thinks management will turn its focus to the “long-ignored” international business, especially in Europe.

Richard Hunter of Hargreaves Lansdown is also relatively optimistic. He says Tesco is addressing previous concerns via its transformation programme.

“Perception of the company has recently improved and their proposed revamp of its store offerings and growth in the online business are worthy of note,” he says.

With a supportive dividend yield of 4%, the market consensus has recently strengthened and has now returned to its former status of a ‘buy’, he adds.

However, analysts at The Share Centre are more cautious.

“Given that the global economic slowdown is likely to remain a challenge, as well as fierce price competition and promotions, we continue to recommend investors ‘hold’ as we believe that the shares could be dull for a period, leaving investors to focus on the yield.”