Tesco slump not over, warns City

A third profits warning of 2014 has plunged Tesco into a new crisis, and one entirely of its own making. Add accounting errors to the list of supermarket's problems, and the outlook is bleak, just ask the pessimists at Espirito Santo.

"With poor value for money scores due to questionable pricing architecture alongside poor produce quality, both based on our proprietary surveys, we think there remains a scenario where Tesco UK margins can go to zero," writes the investment bank.

"The extent of overstatement or impact on other parts of the P&L remains unclear at this stage," it says, but decides to slash its earnings per share (EPS) forecast for the year to 28 February 2015 by 13% to 17.1p. That drops to 16.2p in 2016.

Source: S&P Capital IQ

That implies a UK profit margin of 2.7%. But with prices over a third more expensive that Aldi, questionable pricing architecture and an ailing non-food business, "we believe that Tesco could eventually generate zero profits in the UK  the extent of the risks to us remain large and uncertain," says Espirito, which also reckons "there is downside to current market valuations" to the property portfolio, currently valued at 220p per share.

"We think a turnaround at Tesco could take another three to five years."

Even at 210p, Tesco shares trade on 12.3 times forward earnings, rising to 12.9 for 2016, and on enterprise value-to cash profits multiples of 6.6 and 6.8 respectively.

That's still too dear, and Espirito slashes its target price from 190p to 165p. Sell, it says.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.