Why I’m Siding with Warren Buffett on This Investment Disaster

One of Berkshire Hathaway’s largest equity holdings tumbles. Is Warren Buffett losing his Midas touch?
Over the past week, Warren Buffett has been featured in numerous news articles due to a rare occurrence: One of Berkshire Hathaway’s (NYSE: BRK.a) top equity holdings has suffered a punishing lost.
Berkshire’s most recent letter to shareholders (published this past March) reports that it owns over 301 million shares (3.7% of outstanding shares) of Tesco PLC (LON: TSCO) (OTC: TSCDY).Unfamiliar to most U.S.-based investors, Tesco is a large British-based grocery chain, with stores spread across the United Kingdom, Europe, and Southeast Asia. The company employs over 500,000 workers, operates over 6,000 stores, and generates over $100 billion in annual revenue.
Tesco investors have had a tough go of it in 2014.  Through most of the year, its shares have drifted lower to 230 pence  from 335 pence. (100 pence equals a pound; one pound equals $1.62).  That’s a 31% decline. It got worse last week when Tesco shares tumbled to 180 pence. Year to date, Tesco shares are down 45%.
I’ll switch to dollars to highlight Berkshire’s hit. Berkshire paid roughly $5.60 per Tesco share. Today, those shares are worth roughly $2.92 (based on the exchange of £1 equals $1.62 in recent trading). In other words, Berkshire has lost $806 million on a $1.7 billion investment. (This, of course, assumes Berkshire continues to hold the same number of Tesco shares it reported at the end of 2013.)
So what’s wrong with Tesco?
Last year, the company issued a profit warning because of increased competition from German deep-discounters Aldi and Lidl. Exacerbating matters, management stunned investors when it announced last week that it overestimated first-half 2014 profits by $405 million. In turn, the dividend was cut 75% (which I believe is temporary). Britain’s Financial Conduct Authority, a regulatory agency, subsequently stepped in and notified Tesco that it has commenced a full investigation on the company.
Despite negative press Berkshire has received on its Tesco investment, I doubt Buffett is distressed, or even contrite. As he once said, “You shouldn’t own common stocks if a 50% decrease in their value in a short period of time would cause you acute distress.“
Moreover, I would not be surprised if in next year’s shareholder letter we discover Berkshire owns even more Tesco shares. To quote Buffett again: “A great investment opportunity occurs when a marvelous business encounters a one-time huge but solvable problem.”
Tesco’s accounting scandal is a big deal. Tesco’s management has taken a kidney shot, and deservedly so. But the table has been cleared: Four top managers have been suspended and a new CEO and CFO are on board. Their reputations are at stake. Change you can actually belief in is on the way. Problems will be addressed and likely solved.
In short, Tesco’s accounting scandal will be water under the bridge in due time . . .  I expect within a year. That said, issues concerning competition and loss of market share are more chronic, but still solvable.
Turning around a struggling grocery giant isn’t as monumental as Tesco detractors lead you to believe. Dutch supermarket Ahold and France’s Carrefour are two grocery chains that managed to right the ship after being torpedoed by accounting scandals and performance problems. (I’ve shopped at both, and they are fine.)
Today, you have the rare opportunity to capture a better entry price than a premier investor, and you can do it how you like: Tesco shares trade both in the U.K. in pounds and in the United States in dollars. If you prefer dollars, buy the symbol TSCDY.  The price action is nearly identical in both issues.

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