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Is Tesco an Exciting Emerging Market Play?

Wednesday - 5/1/2013, 2:29am  ET

LONDON -- While crippling austerity in Europe and fiscal obstacles could put the brake on growth rates there, in developing regions a backdrop of accommodative central bank action, elevated commodity prices, and rising personal affluence levels have created an environment of exceptional commercial opportunity.

The divergence between the growth prospects of traditional and developing markets is borne out by latest International Monetary Fund's (IMF) growth projections, which expect developing nations and emerging markets to expand 5.3% and 5.7% in 2013 and 2014, respectively. By comparison, it anticipates that the U.S. economy will rise 1.9% this year and 3% in 2014, while eurozone GDP is forecast to dip 0.3% in 2013 before rebounding just 1.1% next year.

Bubbly activity in these developing geographies can create large opportunities for many London-listed firms. Today, I am looking at Tesco  (NASDAQOTH: TSCDY) and assessing whether its  operations in these regions are likely to underpin solid earnings growth.

Profits slip as U.S. exit confirmed
Tesco announced in this month's full-year results release that annual profits slipped for the first time since the mid-1990s for the 12 months ending Feb. 2013, with statutory profit before tax nosediving 51.5% to 1.96 billion.

In addition to taking a massive 804 million pound writedown on the value of its U.K. assets and writing down almost 500 million pounds on its Polish, Turkish, and Czech operations, the company finally confirmed its exit from its Fresh & Easy U.S. venture, which has struggled since its inception a little more than five years ago. The doomed venture caused the supermarket to take a hit in the region of 1.2 billion pounds.

Tesco has extensive operations spanning the globe, but the U.S. is not the only area where it has experienced difficulties. It was forced to exit Japan at the start of the year after failing to generate sufficient business during its nine-year stay. However, the market continues to make headway into other parts of the world, most notably still in Asia.

Asian operations keep on rolling
The supermarket saw sales in Asia hit 12.3 billion pounds last year, up 6.1% on a constant currency basis. Tesco's operations span the continent, with activities in China, India, South Korea, Malaysia, and Thailand. The company plans to open 2.8 million square feet of new retail space in Asia this year.

Sales surged in Thailand last year as Tesco's store openings there ramped up, although trading hour restrictions in Korea weighed heavily on regional performance. But the company sees the region as crucially important for future growth and plans to follow up its successful launch of online shopping in Thailand last year with the launch of its Internet service in China this summer.

The supermarket's fortunes in Eastern Europe -- Tesco has operations in Slovakia, Hungary, Poland, and the Czech Republic, among others -- has tipped lower recently, however, with sales there rising just 2.1% at constant currencies last year to 10.8 billion pounds. Tesco has scaled back its new store openings here due to the impact of harsh economic austerity and falling consumer confidence.

So is Tesco a buy?
City brokers expect earnings per share to edge 1% higher in 2014 to 33 pence, before rising 6% in the following 12-month period to 35 pence.

The supermarket chain kept the full-year dividend on hold at 14.76 pence despite last year's earnings decline, and analysts expect the dividend to gain traction again from this year as financials improve. A total dividend of 15.2 pence per share and 16.1 pence per share is expected in 2014 and 2015, presenting yields of 4.1% and 4.4%. This is ahead of the forward average of 3.5% for the food and drug retailers sector and 3.3% for the FTSE 100.

Tesco currently trades on a P/E ratio of 11.1 and 10.5 for 2014 and 2015, correspondingly, providing decent value for money when compared against a prospective earnings multiple of 13.3 for the wider food and drug retailers sector.

I believe that Tesco has what it takes to turn its fortunes around. The firm has huge resources and the know-how to recover market share in the U.K., and its withdrawal from the U.S. should finally put a lid on its failure there and help it to concentrate efforts back home.

Meanwhile, rising activity in developing markets, particularly Asia, should bolster the turnaround story over the long term, while galloping online grocery transactions -- sales here rose 12.8% last year to 2.3 billion pounds -- should provide crucial earnings growth support.

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