Sometimes foresight may not help. If someone had said on 28 August last year (just before Tesco announced its second profit warning of 2014 and a 75% cut in its interim dividend) that over the next few months the company would issue three profit warnings (halving expected profits for the year), stop paying its dividend and admit to a major accounting misstatement, which company would you have expected to perform better: Tesco or Sainsbury? If you’d guessed Sainsbury, you would have been wrong. The chart below shows the performance of both since then: Tesco has fallen by “only” 15%, while Sainsbury has declined 17%. The market may, of course, be supremely efficient, having already discounted Tesco’s problems (Tesco has fallen more over the last 12 months), just as it is now starting to anticipate a recovery. Perhaps.
I warned in August about Tesco’s high debt levels and that it risked losing its investment grade credit rating (see “Aggressive accounting hides financial weakness”). At the interim results, the new management identified “strengthening the balance sheet” as one of their three priorities. As part of its post-Christmas trading update on 8 January, the company has said it will give more details on its future strategy. It is widely expected to announce the disposal of a number of non-core assets, and possibly some or all of its operations in Asia. However, the problem facing Tesco is that its debt is so high and its profits are currently so low that whatever it decides to do, even spinning off its Asian business, will not completely resolve its balance sheet issues and is unlikely to prevent a downgrade in its debt to below investment grade.