Investment Column: Tesco should be in any investment basket

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The Independent Online

Tesco

Our view: Buy

Share price: 391.4p (+1.4p)

The Tesco juggernaut has rolled on remorselessly over the last decade. But at today's interim results, the retail giant is expected to post second-quarter underlying UK sales growth of just 3.5 per cent. That will again leave it trailing Asda, Sainsbury's and Morrisons. Furthermore, Tesco is forecast to deliver group pre-tax profits of £1.46bn for the six months to the end of August, compared with £1.45bn last year. This will be the first time since 1999 that it will have posted a rise in interim pre-tax profits of below 10 per cent.

Of course most retailers globally would give their left arm for similar numbers. But Tesco – which has a 30.9 per cent share of the UK grocery market – will not be happy about its lagging behind its big three domestic rivals. Despite its overseas forays, UK food retailing still accounts for about 70 per cent of group profits. Analysts will be hoping Tesco's chief executive, Sir Terry Leahy, has good things to say about UK customers' response to the £350m investment into the Clubcard loyalty scheme since May.

Still, in the long term, there is much to recommend in Tesco's shares. They have rallied since March, and now trade on a 2010 forward price-to-earnings ratio of 14.4 – only slightly above the retail sector average. Tesco also still has a strong long-term growth story to tell, particularly with its retailing services, non-food offerings and international markets, such as China, South Korea, Poland and the US. The retailer believes there is a huge opportunity to grow financial services revenues (and it may be right, given that its brand is trusted while most financials are anything but), and could launch bank accounts as early as the final quarter of next year in the UK.

While the company has undoubtedly lost momentum in UK food, we still think on a medium to longer-term horizon, Tesco should be a core part of any investor's shopping basket. Buy.



Wolfson Microelectronics

Our view: Sell

Share price: 122.25p (-12.5p)

Wolfson Microelectronics makes chips that go in mobile phones and smartphones, which is one of the sectors still growing despite the downturn. Unfortunately, while its chips can be found in old iPhones, they are not in the new one. Wolfson yesterday said its backlog (order book to you and me) had been "adversely affected by a faster than anticipated shift in product mix at a major customer following a previously announced design loss".

In other words, Wolfson-free new iPhones (and other smartphones it doesn't supply) are taking over faster than expected. Especially in China.

The effect of this could be seen in its third-quarter trading update, which showed that revenues came in $4m short of expectations, at about $35m for the quarter. What's worse, Wolfson says demand is poor, and customers are only making decisions at the last minute. So earnings visibility is very limited. The group said it was encouraged by the traction with some of its new products, and highlighted a contract win analysts believe to be with Nokia for a handset in the US. It believes that revenues will be up next year as a result, but not everyone is convinced. The analyst John McPate of Evolution Securities, who used to work for Wolfson, said he had lost count of the profit warnings, and said the reasons given for the poor performance were "utterly useless". The new management team looks decent, but this doesn't look like a great bet. Sell.



Eros International

Our view: Buy

Share price: 196p (+7,5p)

Eros International was set up to bring Bollywood to the world. Well, maybe. There have been some successful migrations but no real crossover smash along the lines of Crouching Tiger, Hidden Dragon, or Hero. Not that it matters that much, because in South Asia there is a huge market for Eros's product. So who cares if it remains (mainly) restricted to those of South Asian descent in the West? The demographics in India alone are compelling, with a fast-growing middle class and cinemas springing up like weeds. The company is planning to list up to a quarter of shares in its Indian subsidiary on the Bombay Stock Exchange, to provide capital for corporate activity. It will also exploit the higher valuations currently being enjoyed for media in Bombay relative to London. With a rock-solid back catalogue, a good pipeline and some "issues" with Indian cinemas resolved, things look good.

Corporate governance remains a concern, particularly in an industry where investors' interests have not always been well served, but at just 7.7 times 2010 full-year earnings, the shares look cheap, and are worth a punt. Buy.

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