The Bull thesis
By leveraging its extensive consumer data, Tesco can launch products that have superior market fit. Increasing white-label product sales are going to have a positive impact on margins. Tesco simply have the leverage and data advantage, to take this market share away from exciting food and beverage brands.
Furthermore, Tesco can efficiently scale their product mix, by leveraging the Tesco brand into mobile services, insurances and ecommerce.
Tesco has a ton of prime locations, that new entrants would have to compete directly with if they want to take market share and grow in UK. Furthermore, they have economics of scale to leverage stronger deals with suppliers and decrease overall costs.
To sum: Tesco has strived to improve their brand equity, and this is reflected in their market share development. All the while, the Tesco brand can be leveraged across services.
The Bear thesis
Tesco has previously failed entering USA and ASIA. This makes the case for a limited runway – market growth strategies, might not be for Tesco. Tesco is highly exposed to the UK consumer, and growth is limited to increasing share of wallet. Market penetration strategies have simply not been feasible. Especially with Tesco’s local appeal. Competition from Aldi and Lidl is likely to affect margins and earnings growth for the foreseeable future. White Tesco is considered a consumer stable, and they are – earnings are likely to be slightly affected by volatility in consumer purchasing power in the UK and input costs. Furthermore, the British pound has underperformed the EUR and USD for a while now and might have a material impact for the foreign investor.
While the bull case for Tesco heavily emphasizes margin expansion, the UK governments are heavily opposed to increased food pricing, possibly creating a regulatory risk if grocery stores become too profitable. Tesco’s brand is not strong enough, as consumers simply don’t care if they shop at Aldi, Lidl or Tesco. They are picking the cheapest and most convenient grocery store. Finally, A 5–10-year corporate bond provides a yield similar to Tesco’s at current valuations.
To sum: Competition is fierce, market penetration growth is limited and risks pertain.
Conclusion
I believe Tesco is going to increase its margins, through white labels and improved brand equity – but their market share is most likely to stay flat in the short to midterm. I assess Tesco to be fairly valued, trading at a premium to other retailers. This is not unreasonable since they are and have the potential to expand product categories in both vertical and horizontal integration.
They have a brand that Is deeply embedded in UK culture and that people increasingly trust (partly attributed to past setbacks). Issue comes with brand dilution, people don’t trust cell phone providers and especially not insurance companies. This will increase distrust in Tesco, hurting their brand equity.
In all fairness, investing in grocery stores drives similarities to investing in car makers or airlines. Massive competition drives uncertainty about future growth and compressed margins.
Tesco at a pe above historical averages, above industry averages in a risky macroeconomic/regulatory environment does not condone investing.
I appoint a sell rating, as Tesco fair value is PE 13. 23% below current PE. Note: Tesco might be able to leverage their brand across segments, gain market share etc. but based on their marketing strategy this is too questionable. There are even better investment opportunities in today’s hyped markets. Consumer staples as a sector have underperformed, and rightfully so – they were way too expensive! But they are still not value.
About Tesco
Tesco is Tesco, Tesco Mobile (UK’s biggest mobile network operator), Tesco insurance & money services, One Stop, Booker (UK’s leading food and drink wholesaler) & Dunhumby (A global leader in customer data science).
Tesco is in five markets, with UK being the most significant market (in terms of size). Tesco is the leading grocery retailer in UK with 28% of the market share and 4500 stores. Tesco also has 180 stores in Ireland, 180 in Czech Republic, 180 in Slovakia and 200 in Hungary.
The Tesco Brand (grocery stores)
Tesco Grocery Stores (CBBE):
Tesco brand salience (awareness & recognition)
Tesco, with their long history and massive presence in the physical environment in UK drives high awareness and recognition. Most consumers in UK, have at some point evaluated their opinion on Tesco for better or worse. This creates strong brand nodes, which makes consumers able to quickly know exactly what the Tesco symbol symbolizes (depth). The frequency of how often these brand nodes are recalled is highly dependent on the physical environment (width).
Brand Image (identity mix)
Tesco’s supermarkets are generic supermarkets. They don’t particularly appeal to the seven senses. They are brutalist like architecture with bad smells. They are not made to be pleasant experiences. They are created to be convenient and offer large selections of groceries. Tesco’s stores are massive, offering a wide range of products.
Tesco is a low-price mass retailer, and prices its products as so. With some premium products. Tesco’s white label brand (Tesco Finest) is not an exception, these are meant to be premium products.
Tesco’s employees are wearing generic ( ugly ) uniforms. The logo has not been updated since inception, and is a rigid red text stating Tesco. This is visible on the front, on the employees and on the shopping bags.
Tesco’s promotions are personalized offerings with email/app notifications and tv advertisements. Tv advertisements are good at reaching an older audience and create awareness (top funnel). App/email notifications are good for driving loyalty (bottom funnel).
Brand Performance
The primary characteristic of Tesco is the accessibility of food. This is a point of parity with other grocery retailers.
Secondary features of Tesco are massive breath of products (note – the grocery store). This is a point of difference from other grocery retailers. Further, Tesco is offering bundled products such as mobile and insurance. That Aldi and Lidl does not.
Brand Judgements & Brand Feelings
Brand judgements is the quality, brand credibility & brand consideration.
Brand feelings is:
- What feelings does the brand elicit in consumers’ hearts?
- How does the brand make consumers feel about themselves and their relationship with other people?
Tesco’s products are a direct reflection of the brands they are selling. Because the product is from Tesco, does not mean it is high quality. This is why food brands are still relevant today; they are something consumers use to identify products and themselves. Tesco’s finest are quality products at a premium price (masstige).
When shopping at Tesco the supposed emotional reactions are the ones of being safe, comfortable and reassured. People want good quality and good price. They want to be reassured they are not cheated or getting sick. Shopping in a supermarket for most is not supposed to be an exciting and/or fun experience. Some might pick supermarkets on the basis on social approval and/or feeling pride. This is not the case with Tesco.
Tesco’s brand credibility has suffered under past scandals, that older demographics (millennials and up) will still remember. Horsemeat in meat products, created distrust to the Tesco products and supply chain. Customers were saying – they don’t even know what they are selling. This lack of credibility makes the customer feel distrust and to an extent hatred towards the brand. How can you know what you are buying is, if the one who is selling it doesn’t even know. This shakes the consumers, as the bottom of the Maslow pyramid is hurt. Another scandal was financial fraud (inflating earnings). This made consumers think it was led by unethical profit first management, hinting at a deeply rotten organization with a toxic culture. Deeply hurting the brand equity and perceived positioning as a local brand (these are supposed to be credible and hold high ethics). Anyhow, these things happened a long time ago but will still reflect the older demographics’ perception. Tesco is no longer the local grocery store; they are a multi-national corporation. Tesco has managed to improve their brand equity; this is reflected in their existence today. There simply would not be a Tesco without trust and credibility. Consumers who have been going to Tesco for years, feel safe going to Tesco – they know what they are going to get and they know they will not get sick. It is the same old. Tesco’s increase in market share can partly be attributed to their improved brand equity.
When consumers consider where to shop, they consider first and foremost convenience (i.e. distance), the prices and the product mix. These considerations might change with consumer trends (i.e. purchasing power). Tesco’s club cards are a massive driver of consideration – especially for users in the paid tier.
Brand Resonance
Tesco’s relationship with their customers is most likely an interdependence relationship. Tesco is dependent on its customers and the customers er dependent on Tesco. In these relationships are more frequent and diversified and endure over time. Even when there is low affective involvement.
Where in Tesco’s is placed in the four categories of brand resonance is difficult to assess and highly polarized. Being a retailer consumers will typically pick the one that is most convenient. This leads me to assess them as behavioral loyalty; consumers use Tesco simply because it is the one that is most convenient for them. But this doesn’t illustrate fluctuations in market share and loyalty cards. In fact, I will argue that an increasing number of consumers have a preference. They have their favorite products, and they know where things are. This moves them up in the brand resonance chain – some more than others.
Tesco omni-channel marketing
Tesco drives omni-channel marketing through their app. Data works as a competitive advantage. Tesco can leverage data points from a single consumer, partly because when consumers buy products in Tesco using their loyalty cards, they create a data point. The loyalty cards further let Tesco keep track and offer personalized discounts using AI. On top of this, data helps Tesco know what products are popular and which aren’t. This helps Tesco select products with a strong product market fit. They simply know what consumers want, before any brand they are selling knows – and this is likely to continue driving market share in their Tesco Finest segment.
Tesco Positioning Strategy
Tesco has over the years expanded into different services, using their Tesco brand (a Monolithic Brand). An approach that can drive high adoption rates, with little advertisement expenditure. The downside is that any harm to the Tesco brand will damage Tesco across its services. This brand architecture allows for the optionality of launching new services, for the investor an important growth driver. The key issue is that, the distrust the average consumer has in financial services might spill over to Tesco.
Tesco’s positioning is using a local positioning strategy. They are appealing to the heritage, nostalgia and the mass. In its DNA, it is a worker’s brand. This is a strong positioning in UK’s proud “Glasgow” culture – creating mass appeal. This is emphasized by their latest support of British farmers and communities. This comes to expression through the identity mix, which I addressed before.
The Tesco Community (Architecture of Affiliation Framework).
Building a strong brand community is not only a marketing strategy, but also a business strategy that must be implemented across the organization. Brand communities drive increased loyalty. Note loyalty has been proven to follow market share, as is the case with the law of double jeopardy and the duplication of purchase law.
Communities are not built around the brand; the brand should be built around the community. This requires a customer centric approach; something Tesco is implementing across all its businesses. Tesco is engaging with and in the community through partnerships with its community – the everyday working joe – through addressing key societal issues such as regulatory pressure on farmers, parental leave and healthy food for kids.
“At Tesco, we are campaigning not only on behalf of all our colleagues but for people and communities across the country. Our view is that reforms are long overdue. Paternity pay in the UK is the lowest in Europe and paternity leave is out of step with how most couples want to share their parenting responsibilities” How Tesco is backing working families
“Our farmers told us data collection, innovation, financial sustainability and collaboration are all areas where we can help, and so that’s where we continue to provide assistance.
Whether that’s testing and scaling innovation on our low carbon concept farms, providing financial support for farmers to achieve shared sustainability goals, or calling on the government to help establish a standardised framework for environmental data, we want to play our part in supporting our farmers and the wider sector” Partnering with our British farmers
“We see the pressure families are under, particularly when budgets are tight and healthy food can start to feel like a stretch rather than a given. As a supermarket, affordability matters, but price alone does not solve the problem. What really makes the difference is everyday access, real, practical opportunities for children to eat fruit and vegetables as part of their normal routine” Free Fruit and Veg for Schools: Our Big Ambition to Reach One Million Children .
Finally, brand communities should not be tightly managed. They belong to the community, and excessive corporate control destroys them. As illustrated with above citations, Tesco is not fighting the community, it is supporting the community/local culture through initiatives.
While it might sound superficial, the people who engage in these activities are the community. It creates a tribe through connections.
Tesco helps build its community through hubs (celebrity endorsements). This is for example the case with Jamie Oliver advertising Tesco Finest. Tesco is closest to a pool affiliation. Tesco’s customers are united by a common goal of cheap and convenient grocery shopping. This type of affiliation is highly scalable because it does not rely on relationships; it can simply be advertised. Pool affiliation is the weakest form because cheap shopping is not uniquely a Tesco thing; it is highly prone to competition from Aldi and Lidl.
Valuation & Ratios
Grocery chains usually trade at a pe around 10-15. Tesco is trading at PE 16.
Tesco’s profitability is very low. With a consistent operating income of around 4-5%. And a net income around 1-2%. These are industry standard, but nonetheless they are unappealing.
Note: Retail is 87% of their operating income.
Tesco now
As Aldi is being perceived as cheaper and running without same loyalty/omni channel features positions them strongly to directly capture Tesco’s local (workers class) appeal. Tesco recognizes this and specifically advertises using a price match on Aldi’s products. Simultaneously, is Tesco targeting (those premium brands) with (their others stores and Tesco Finest). Tesco is currently experiencing regulatory headwinds with considerations of capping food prices on necessities – which to me seem unlikely, as grocery stores are already operating on a low margin. Tesco is seeing growth in its insurance segment.
Disclaimer
Note: this analysis mainly addresses Tesco from a marketing management and strategy point of view. It is by now means an exhaustive analysis of all possible elements – for example it does not address economics of scale, competitive dynamics (porters five forces) or the macroeconomic and regulatory environment facing the company. Neither does it address the whole sale business or telecoms business etc. Investing requires a holistic approach, which accounts for all possible elements, to structure a genuine insight into the company’s current and future prospects for creating shareholder value. Future analysis must address the insurance business, as this is a particularly important aspect of the bull thesis (leveraging the brand). While the insurance business is still small comparatively, it has grown immensely over the last two years. Another important element that could and should be addressed is the vertical integration of, for example, the whole sale business and increasingly farming.
Competitive advantage
Tesco’s biggest moats are not brand equity and consumer loyalty. It is a geographical moat and economics of scale. The geographical moat is the placement of supermarkets, that new entrants will have a hard time competing with. They must either locate in a worse location or next to Tesco and/or another retailer. With the grocery store already running at low margins, this is expensive and thus unlikely to be executed. The economics of scale is leveraging deals with branded goods and cost advantages. Not a very strong moat, in a market with many big players.
