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Buxton eyes Tesco ‘value opportunity’ after contrarians move in

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Old Mutual Global Investors' Richard Buxton is considering buying Tesco for the first time in four years, as managers investigate a contrarian opportunity in the stock despite the spectre of dividend cuts.

The share price of Britain’s largest supermarket has tumbled 25 per cent year to date, shedding 3.3 per cent this month, as it struggles against increasing competition from low-cost rivals.

The firm announced the departure of CEO Phil Clarke last month following another profit warning, and currently trades on a trailing PE of just 10 times earnings, with a dividend yield of almost 6 per cent.

However, the sustainability of that dividend has been called into question: some analysts predict a halving of Tesco’s payout when it reports interim results on 1 October.

Buxton, speaking this morning, said he is “not jumping in just yet” but said he is stress testing the impact of potential price cuts across the business, adding he is “very much alive to the potential opportunity.”

The manager of the £1.5bn Old Mutual UK Alpha fund, who has not owned the stock since 2010, acknowledged a dividend cut may be on the cards when new chief executive David Lewis arrives from Unilever next month.

“It will be an option open to the new chief executive. You can come up with scenarios where they can maintain the dividend payment, though obviously [dividend] cover is going to fall rather significantly.”

Value trap or buying opportunity?

Sentiment on the stock remains deeply negative after a string of disappointing earnings reports, while managers from Neil Woodford to Warren Buffett have sold down stakes in the business.

Jeremy Lang, manager of the Ardevora UK Income fund, has described the stock, which has fallen 42 per cent since the start of 2011, as a “classic value trap”.

Others have gone further: David Urch, manager of the TB EEA UK Equity fund, opened a short in the company last month following the announcement of Clarke’s departure and pointed to its “vulnerable position and unattractive operating environment.”

Urch joins the likes of hedge fund Lansdowne Partners in actively betting against the stock, but others see the falls as a classic contrarian opportunity, where investors seek to profit by going against conventional wisdom.

Investec’s multi-asset team, seeing a similar opportunity, began buying the stock earlier this year.

“The value equity team began to buy Tesco and Morrisons earlier this year, and following this, our own due diligence work has highlighted significant re-rating and growth potential on a two- to three-year view,” Stopford said.

Other well-known managers that still hold Tesco include Schroders’ Kevin Murphy and Nick Kirrage via their £1.5bn Income fund: the stock made up 3.9 per cent of the portfolio as at 30 June.

Majedie’s £2.7bn UK Equity fund, part of a £7.6bn strategy, also has 3.1 per cent in the stock, representing almost their entire exposure to food and drug retailers.

Buxton suggested this morning that he is not alone in taking another look at the supermarket.

“We along with many others in the market are kicking through the numbers, trying to stress test what Tesco could choose to do: more price cutting, taking margins down, and the impact that may have on halting the growth of the discounters.

“Clearly there is a value opportunity here. There is a potential change story. We know the situation is unsustainable, and that has been recognised by the Tesco board.”

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