Tesco: Shareholder Wealth Maximisation

Shareholder wealth is maximised when the share price and dividends of a company are maximised over time.  Basic theory suggests that shareholders are the owners of the company and therefore deserve a share of any surplus wealth generated.  This seems logical, as shareholders are the highest risk bearers when it comes to corporate ownership.  They commit their own wealth and then generally the use of the funds is left to the discretion of the directors of the company.  Companies should seek to return capital to the shareholders as this should attract further investors and in turn provide additional capital to expand the business.

Tesco is an example where, in recent weeks, there has been a substantial destruction in shareholder wealth.  On 12^th January 2012 Tesco shares fell by 61.6p, dropping in value by nearly 16%, and knocking almost £5bn off the market value of the company.  This came after Tesco announced poor Christmas trading figures with like for like sales falling by 2.3% aswell as forecasts that 2012 will see a definite slowdown in Tesco’s profitability.  Clearly, this severely dented investor confidence and led to the extensive devaluation of Tesco shares. Over the Christmas period Tesco reduced prices, in a pricing strategy which commentators have coined the ‘big price flop’, in order to match competitors who had engaged in similar activities.  However Tesco failed to offer any coupons to reward regular spending, unlike its competitors, meaning customers were not properly rewarded for their loyalty.  This mistake is likely to have cost Tesco many customers at the checkouts.  In my opinion as Tesco is the market leading supermarket they should represent the cornerstone of quality, value and choice.  However they have decided to get embroiled in a pricing war with competitors like Sainsbury’s, who have introduced their well marketed brand match policy.  Sainsbury’s was the market leader for much of the 20^th century but is now the third largest UK supermarket chain and has seen its shares fall steeply in value in the last ten years (-34.81%).  It could be seen as acceptable for them to go in a new direction and attempt a daring pricing strategy in order to get customers back through the tills, albeit at low margin.  However, Tesco should not have sacrificed their reputation for quality in order to compete on low prices.  As a result profits, and ultimately shareholder wealth has paid the price.

It recently emerged that a senior Tesco executive sold over £200,000 worth of shares.  Bob Robbins, Chief Operating Officer of the UK business, sold 50,000 shares at 404.5p 8 days prior to the profit announcement.  This compounded the problem for Tesco as the news will surely have damaged shareholder confidence and added to the already negative effect of the profit announcement.  In a statement Tesco stated that “Bob Robbins sold less than 5% of his substantial shareholding in Tesco for necessary family expenditure” and that it was “approved in the usual way”.  Robbins is paid a base salary by Tesco of £832,000 which, according to the companies’ annual report, makes up a maximum of 40% of his total remuneration.  Robbins can earn over £3m in any one year.  The question has to be poised; who is Robbins and the company trying to kid?  Stringent Tesco shareholders should have seen this as a warning sign that it was time to get out and if they didn’t they most definitely did when it emerged eight days later that the companies’ profits were struggling.  The move by Robbins saved him just over £30,000 in share value but what were the repercussions of his actions for the remaining shareholders wealth.

However Tesco shareholders cannot have too much to grumble about surely?  Despite the recent dip in share price, Tesco shares have risen by 74.91% since the turn of the millennium.  This is in stark contrast to the FTSE 100 which has declined by 13.3% over the same period.  Tesco also paid out over £1bn in dividends in 2011.  Shareholder wealth has certainly been maximised as the company has witnessed unprecedented growth, largely down to its ongoing strategy to increase market share.  Tesco controls over 30% of the UK supermarket industry and in 2007 one in every seven pounds spent in the UK was at Tesco.  However, I would argue that perhaps too much emphasis is placed on the desire to maintain this high level of market share within the Tesco board.  The festive pricing strategy was seen by many as a decision made simply to match up to competitors and maintain the status quo, with Tesco by far and away the market leader.  Shareholders have good reason to be dissatisfied as the poorly thought out pricing strategy has caused to some extent the new year profitability warning and resulting share price drop.

Tesco’s growth previously has been achieved through the mass construction of superstores all across the UK to provide customers with a one stop place for all of their consumer needs.  However, I feel that there is beginning to be a shift in the UK market from superstores to convenience.  Customers no longer want to visit out of town superstores, they still want quality, choice and value but in a more convenient location.  This provides a challenging outlook for Tesco. In his BBC blog Robert Peston summated that “Companies have an organic quality. They have a lifecycle. No business continues on a path of unbroken growth forever”.  Have Tesco reached the peak of their growth?  They certainly have to rethink their strategy to help the company and ultimately maintain their good track record as a shareholder wealth maximiser.    Philip Clarke, Tesco CEO, recognised the challenge they faced, stating that “what is at stake is whether the core of this huge global business, the UK stores, can regain their vitality or must become reconciled to long-term stagnation or even shrinkage.” They cannot afford to have too many more days like the 12^th January or the slope may start to become even slippier.

It is worth noting that the supermarket industry has struggled across the board so far in 2012.  UK traded competitors Sainsbury’s (-2.58%) and Morrisons (-9.5%) share price has also declined since the new year.  Why is this the case?  During the recession supermarkets have generally been regarded as a ‘safe haven’ having remained strong or at least maintained their value to shareholders.  This has reflected consumer trends to eat out less and purchase higher quality ingredients to produce home cooked meals.  It may be that the recent decline was just a blip due to a tight Christmas and the growth of more savvy customers.  But, more likely, the signs for the general economy are that alarming that customers are watching there pennies at the supermarket checkouts now just as much as the high street.  If so this could be a worrying time for supermarket shareholders.