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Trader Talk is produced by a team of active traders, analysts and various derivatives professionals from multiple organisations. Trader Talk provides comment on equities, commodities, and other financial instruments based on both technical and fundamental analysis.
Tesco property time bombNovember 22 2014, 7:00am
It has been a quiet week for equities after a strong recovery, with positive US sentiment offsetting growth concerns in the Eurozone and Asia.
The S&P 500 achieved a record close this week, despite weaker than expected manufacturing data from the world’s biggest economy. US factory production rose 0.2% last month, while September’s increase was revised down to 0.2% from 0.5%, indicating some slowing in economic growth at the start of the fourth quarter.
The highly anticipated minutes from the latest US Federal Reserve policy meeting proved to be relatively uneventful, with little change in wording. The Fed remains on track to hike rates in circa 12 months’ time based on the economy tracking their forecasts.
Eurozone data indicated further weakness in the region after business growth came in weaker than analysts had expected. Markit’s composite flash PMI, based on surveys of thousands of companies and seen as a good growth indicator, fell to a 16-month low of 51.4 this month from 52.1 in October, while similar surveys on the service and factory sectors plunged further than expected. Forward looking indicators suggest the situation is unlikely to improve anytime soon, with a new orders index contracting for the first time since July 2013.
German stocks, however, improved after a closely watched survey indicated the mood in Europe’s largest economy appears to have improved, supported by easing measures from the ECB. Zew’s monthly survey of economic sentiment rose to 11.5 points from -3.6 points in October, well-ahead of forecasts for a rise to 0.5 points and its first increase since December 2013.
Asian markets were volatile, as the Nikkei 225 initially dropped after Japan unexpectedly slipped into a technical recession, before recovering as news that Prime Minister Shinzo Abe confirmed he would postpone the scheduled tax rise for 18 months and go to the polls in December.
Meanwhile, fresh data signalling a further loss of momentum in China’s economy weighed on sentiment, as new home prices fell in virtually every city surveyed and a manufacturing PMI contracted for the first time in six months in October. The weak data combined with the greenback’s rise put additional pressure on dollar-denominated industrial commodities, with oil, gold and iron-ore prices drifting to multi-year lows.
On a domestic front, retail sales rebounded strongly in October after a heavy fall in September, driven by purchases of furniture after the housing market picked up speed earlier this year. Retail sales volumes rose 0.8% after a fall of 0.4% last month, as mild weather put shoppers off buying winter clothes.
Technical analysis of the FTSE 100 illustrates the steady uptrend evident over the past month, as the blue-chips claw back from the October correction. The fading oscillators, however, suggest the momentum behind the rally is diminishing, with the bearish divergence often acting as a precursor to a correction. Support is seen at 6650, 6535 and 6420, while a re-test of the recent highs might be needed to reinvigorate the bulls.
In conclusion, the recent recovery demonstrates the underlying strength in equities, despite many of the headwinds that led to the October correction remaining. Chinese and Eurozone growth appears to be slowing, while active ISIS militants and Russia’s involvement in Ukraine ensure geopolitical uncertainty remains. Given the vulnerable short-term technical outlook combined with the end of US earnings season, indicates a period of profit taking could occur.
Industry data showed Britain’s grocery market has suffered its first three-monthly sales decline in at least 20 years, adding to the pressure on the supermarkets as they gear up for the key Christmas trading season. Monthly numbers from Kantar revealed UK grocery sales fell 0.2% to £24.88 billion in the 12 weeks to 9th November, marking the first decline since records began in 1994.
Competition from fast-growing German discounters Lidl and Aldi have sparked a price war, chipping away at the market share of their bigger competitors. Market leader Tesco (Epic: TSCO) is bearing the brunt, with sales falling 3.7% in the period, while Lidl and Aldi added 16.8% and 25.5% respectively. Tesco’s overall market share is down to 28.7% from almost 30% 12 months ago.
It is also becoming harder to value these businesses, with the value of assets underpinning the shares falling, little clarity on future profitability and dividends being cut. Investors have often talked about the assets of the UK supermarkets supporting the valuation, with the value of Tesco property said to be worth £21 billion, over 30% more than the market capitalisation.
Yet there are growing concerns over the quality of those assets, with the gap between the performance of large out-of-town stores and convenience stores widening, undermining the value of these out-of-town warehouses. Sainsbury’s recently took a charge of £663 million related to its property portfolio, while some analysts argue that Tesco’s assets could be worth less than half the book value indicated on the balance sheet.
Tesco still trades on a relatively full 12x prospective earnings, although falling revenues, profits and a failure to issue full-year profit guidance makes it hard to value the business. Tesco’s interim results on 23rd October showed net profit fell to £6 million in the six months to 23rd August, compared with £820 million in the same period last year, while revenue dropped 4.5% to £30.47 billion.
The groups pension deficit ballooned by £800 million since February to £3.4 billion, squeezed by declining returns on corporate debt. Meanwhile, the interim dividend has already been slashed by 75% and management are expected to cut the final by a similar amount, leaving an annual yield of 2.5%.
The chart of Tesco illustrates the 18-month downtrend, with the 50-day moving average providing resistance to any spikes. After rallying 15% in the past month, the shares appear to have run out of steam, with the bearish divergence evident from the declining oscillators, indicating the underlying momentum is fading.
Tesco has fallen a long way, but with margins under pressure, assets vulnerable to write-downs and an ongoing investigation by the serious fraud office for fiddling its accounts, leaves Tesco susceptible to further weakness.
At the time of writing the share price is 194.0p and the downward momentum suggests trading short. Near term targets are seen at 186.25p, 177.5p and 167.8p, while a stop-loss above resistance at 201.75p could be used to minimise risk.
This report was written by Mark Allen – Head of Derivatives at Simple Investments Stockbrokers. The writer does not hold a position in Tesco, but client accounts may. The material in this report has come from Simple Investments internal data sources, Simply Charts and Tesco’s corporate website.