Now that Amazon (NASDAQ: AMZN) has decided to enter the European grocery business, it is a good time to ask if grocers over there make money. A good place to start is the United Kingdom’s largest supermarket operator; Tesco PLC (OTC: TSCDY).
For Americans and others unfamiliar with it Tesco operates around 3,739 stores in the UK alone, which is a lot. Its operations include 479 Tesco Extra superstores, 1,740 smaller Express locations, 176 Tesco Metro, and 780 Tesco One Stop stores.
Besides that Tesco also has operations in India, Malaysia, Thailand, Hungary, China, Ireland, Poland, the Czech Republic and Slovakia. It also operates the Tesco Bank which serves seven million accountholders in the UK and a data services, marketing, advertising, and consultant firm called dunmhumby.
Tesco controlled around 27.6% of the UK grocery market in March 2017; nearly 12% more than its closest rival Asda which controls around 15.7%, Statista data indicates. Tesco has been losing market share in recent years, in 2015 it controlled 29% of the grocery business in Great Britain.
Can Tesco Compete with Aldi and Lidil
Most observers blame the entry of the German discounters Aldi and Lidil into the British grocery market for Tesco’s slippage. Aldi’s share of British grocery purchases grew from 4.9% in 2015 to 6.8% in March 2017. Lidil’s went from 3.5% to 4.9% during the same period.
This should concern U.S investors because Aldi is expanding aggressively in the US and Lidil recently entered the market. Both chains are challenging the two largest U.S. grocers; Walmart (NYSE: WMT) and Kroger (NYSE: KR) in their Midwest and southern heartland with aggressive discounting.
This means the present state in the U.K. might give us a pretty good picture of what the U.S. grocery business will look like in a few years. American grocers are facing some of the same problems including price deflation and an explosion of competition.
Tesco’s struggles mirror those of those of U.S. grocers. Like Kroger it has a massive amount of revenues ($72.16 billion or €61.11 billion on August 31, 2017), and limited income ($886.45 million or €750.69 million on the same day.)
Tesco’s income has increased dramatically in recent years as recently as August 2015 it reported a $9.4 billion (€7.96 billion) loss. That became a $611.04 million (€517.46 million) income last year and grew into $886.45 million (€750.69 million) earlier this year.
Tesco also managed to generate $2.758 billion (€2.34 billion) in cash from operations on August 31, 2017. That figure was down from $3.807 billion (€3.22 billion) on the same day in 2016 – which indicates that Tesco is making a lot less money than last year. It also managed to make $1.414 billion (€1.20 billion) in investments on the same day.
Despite that, Tesco has quite a bit of float for a retailer in the form of $8.173 billion (€6.92 billion) in cash and short-term investments on August 31, 2017. It also accumulated $60.60 billion (€51.32 billion) in assets by August 31, 2017; which is also pretty good.
Is Tesco a Value Investment?
All this gave Tesco a Market capitalization of $20.31 billion (€17.20 billion) and an enterprise value of $26.98 billion (€22.69 billion) on October 9, 2017. That and a stock U.S. stock price of $7.44 (€6.30) seem to indicate a value investment.
Tesco investors did receive a 9.04% return on equity on August 31, 2017. Unfortunately, the company’s dividend appears to be history the last recorded payout was on August 30, 2014, when investors received just 4.6¢ (€0.04) a share. Therefore it is easy to see why Warren Buffett dumped his Tesco stock.
Despite all this, I think there’s some strong growth potential at Tesco because of its huge brick and mortar footprint. That alone should be worth something in the age of Amazon.
Will Amazon team with Tesco?
Amazon is looking for brick and mortar partners and acquisitions. It bought the US grocer Whole Foods, entered into a partnership with the American department store Kohl’s (NYSE: KSS) and approached France’s largest grocer E. Leclerc about a partnership.
Some sort of Amazon/Tesco arrangement would make a lot of sense. Tesco might serve as a pickup point for Amazon orders in the UK or for returns. It might also enable Britons to pay for Amazon orders with cash at its stores. A major resource would the smaller Tesco locations in British cities, the Metro and Express stores.
Beyond that Tesco might serve as Amazon’s grocery partner in the UK providing food for Amazon Fresh. Tesco stores would also be a good place to sell Amazon products like the Fire and the Echo in the UK.
Tesco might also serve as Amazon’s brick and mortar in other countries such as Hungary, Thailand, and India. This might help Amazon penetrate some of those markets.
Why Amazon and Tesco might Need Each Other
Such a relationship would make a lot of sense because Britain’s third-largest grocer Asda which had a 15.7% market share on in March is owned by Amazon’s archrival Walmart. Since Walmart is expanding its online grocery operations in the UK, teaming with Amazon would be a good way for Tesco to combat it.
A final possibility would be for Amazon to buy Tesco. That would make a lot of sense because Tesco has the grocery expertise Amazon lacks.
Tesco’s recent experiences should be a cautionary tale to U.S. investors because it has managed to make money in the face of declining market share and growing competition. Tesco will survive, but it faces some tough battles in the years ahead – which might make an alliance with a powerful ally like Amazon a necessity.
A slightly different version of this article previously appeared at Market Mad House.