Why you'd be mad to buy Tesco plc and Sirius Minerals plc right now
On the face of it, full-year results from Tesco (LSE: TSCO) in April paint the picture of a grocer on the mend: an increase in total sales for the first time in several years, operating margins rising, and a drastic reduction in net debt. Underneath these headline results, though, there are still significant problems lurking for Tesco.
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Chief among these issues is that although Tesco may be righting the ship internally, it still trades in a hyper-competitive industry with too many stores and no real overall growth. The latest Kantar Worldpanel figures show total UK grocery sales increasing only 0.1% year-on-year over the past 12 weeks. Not coincidentally, this was the same amount by which Tesco's total sales rose for the past year.
More damning for Tesco was Kantar's finding that grocery prices continued their run of declining every month since September of 2014. Lower prices are undoubtedly great for you and I, but for Tesco they're the reason operating margins have fallen from 6% five years ago to the dismal 1.2% posted over the past year. Although this was an increase on the 1.1% posted the year prior, there's little reason to believe they'll rise significantly as price wars continue amongst the major grocers.
Bringing net debt down 40% to £5.1bn was a major step forward, but was largely the result of receiving £4.1bn from selling Korean operations. With few major non-core assets left for sale, future debt reduction will have to come from operational cash flow, which will inhibit a quick return to the high dividends Tesco once paid. Furthermore, with shares trading at 22.9 times forward earnings, the company isn't even a deep value play.
A bridge too far
Prospective Yorkshire miner Sirius Minerals (LSE: SXX) has made waves with its plan to construct a mine and 23-mile tunnel under the North York Moors National Park. This ambitious engineering feat aside, there are a number of reasons I would avoid the shares for the time being. First, the company's latest feasibility study estimates the total cost for the first phase alone at $3.6bn. Since Sirius only has £29m of cash on hand at year-end, current investors can expect significant share dilution in the future to raise the necessary funds.
Another major worry is the fertiliser Sirius is mining for, Polyhalite. Although Sirius quotes a number of studies showing the positive effects of Polyhalite, and has sale agreements for 35% of its first year's production, there's not currently a large, liquid market for the product. Investing in the producer of a commodity for which you can't readily find historical pricing data worries me when Sirius is factoring a certain price into its financial estimates.
The signed offtake agreements do allay some of my concerns, but the larger risk of investing today in a miner that isn't expecting first production until 2021 is still unnerving. Between now and then construction costs may rise, opposition to mining in a national park could once again become a factor, or the price for fertilizers could remain depressed. These possibilities, alongside the need to raise $3.6bn in debt and equity to fund the project, make it a bridge too far for me to invest in.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
