Is Warren Buffett Scratching His Head Over Berkshire Hathaway's Holding In 'Basket Case' Tesco?

OCT 28, 2014 @ 04:24 PM 

With shares in British supermarket giant Tesco hitting an 11-year low last Friday and ending virtually unchanged at 169.10p (c.$2.80) each this Monday, valuing the company at around £13.70 billion (c.$22.6bn), Warren Buffett, CEO and chairman of Berkshire Hathaway BRK.B +% Inc. and pre-eminent world investor, might be mulling the decision to invest in the UK retailer. Yet despite Tesco’s share plunge - down over 53% since 23 October 2013 - Berkshire Hathaway’s fortunes remain undiminished.  

Mr Buffett has been open enough to say that he made “a mistake” on Tesco, a group in which Berkshire Hathaway still owns just under a 3% stake worth around £400m (c.$658m). So, since 23 October 2013 the value of that investment has declined by over £400m. For most investors - institutional or otherwise - that kind of loss would be too massive a blow to handle, but not Berkshire Hathaway.

This US holding company and its subsidiaries engage in a diverse range of business activities spanning property and casualty insurance and reinsurance, utilities, energy, freight rail and transportation, finance, manufacturing  as well as retail. The common stock of the company is an S&P 500 component and listed on the New York Stock Exchange, with each ‘A’ share having traded at around $208,379 as of 23 October.

That represents an almost 20% increase ($33,799) over the stock’s trading price a year ago. And, even if the stock is down just over $5,000 since their 52-week high achieved on 19 September they are still 31% up from a 52-week low ($163,038) in early May. Therefore the fallout from Tesco, which was the only share to record a loss last year among Berkshire’s top 15 picks, has made no dent in the company.

This is an image of the Tesco store at Kingston Park, Newcastle upon Tyne, England (Photo credit: Wikipedia)

But then that would not be so surprising given that it has over fifty subsidiaries and various equity holdings in an array of US blue-chip companies including American Express AXP -0.60%, Coca-Cola and IBM.

Mr Buffett, dubbed the ‘Sage of Omaha’, held a 3.7% stake in Tesco at the end of 2013 according to Berkshire’s annual report. At the time the holding of 301m shares were worth $1.67bn (c.£1bn). He even became the supermarket group’s third biggest investor after taking an initial stake in 2006 when the chain seemed all-powerful in the UK and was planning what became an ill-fated foray and expansion into the US. Subsequently in January 2012 he increased his stake to over 5% from 3.2% following Tesco issuing its first profits warning in twenty years. Remember Tesco had been a darling of the UK stock market.

Jing Ulrich and Warren Buffett. (Photo credit: Wikipedia)

Fast forward to 2014 and the profits warnings from Tesco came thick and fast, with three issued over a 4-month period. The shares lost 30% in value between 8 August and 3 October, but have fallen by a whopping £13bn since the start of this year. With around 8bn shares in circulation a drop of just 10p (c.16.5 US cents) equates to over £800m being wiped off its market capitalization. So, we are not talking peanuts.

To some though it might appear a tad strange that Berkshire decided to reduce its Tesco holding below the 3% mark only this October. In a notification to the London Stock Exchange dated 16 October, the company revealed that its holding (at 245,298,335 shares prior to the announcement), had fallen below and crossed the 3% threshold in a transaction that had taken place on 13 October.

The Daily Telegraph’s Questor column, for example, reiterated its Sell advice on 21 October on Tesco, which followed the same advice (Sell) made as far back as 2 October 2013 when the shares were trading at 358p each.

Ahead of Tesco’s interim results last week (23 October) the British paper pointed out that the retailer’s shares were “uninvestable” given a number of well-documented issues and problems it faced - including a £250m black hole in its accounts, an on-going investigation by the Financial Conduct Authority, the UK regulator, falling sales and balance sheets woes.

Elsewhere, Terry Smith, the former CEO of inter-dealer broker Tullett Prebon and founder of Fundsmith, which has turned £10,000 into £17,300 in under four years, warned a fair while ago that Tesco exhibited worrying issues in regard to its return on capital.

All these problems were enough for David Herro, a fund manager at Chicago-based Harris Associates, to sell just under 1% of Tesco (worth around £140m at last Friday’s closing price) in the days leading up to the retailer’s interim results statement and liquidate his entire investment in the company. Now an American pension fund has sounded off about legal action against Tesco. But that begs the question as to why it has taken so long for such a move to surface.

In terms of analyst opinions on Tesco, data from Thomson/First Call reveals that just two equity analysts covering the stock rated it as a Buy. Again not surprising. The majority (15) rated it a Hold (up from 13 last month), while five rated it Underperform and none a Sell. One analyst, Rickin Thakrar at Espirito Santo, has even suggested that Tesco could eventually generate “zero profits” in the UK and expressed the view that the risks remain uncertain.

The signs might not look to0 rosy for Tesco at the minute given a 4% loss in sales in the 12 weeks to 17 August 2014 compared to the same period in 2013. It nevertheless still commands just under 30% of the UK supermarket industry - even if sales are falling and discount retailers (Aldi and Lidl) are growing.e 

Bottom fishers might consider Tesco an oversold stock, but there are risks. And, predicting just where the bottom is for the stock is tricky. That said, the UK supermarket sector as a whole could witness consolidation. Indeed, in recent weeks there has been market talk that rival grocer Sainsbury’s (shares 40% down since October 2013) and Marks & Spencer could be getting together. However, I doubt for now Mr Buffett is losing too much sleep over Tesco.