In the summer
of 2014, Tesco unexpectedly announced that they would be cutting their interim
dividend by a huge 75 percent, and reducing their capital investments by 16
percent (Thesing, 2014). This news came just a week before their new CEO was
due to start. Their new CEO, Dave Lewis, former veteran at Unilever will take
charge with no real experience of working in the supermarket sector. The fact
that they have appointed a marketing man, rather than an experienced chief
displays the great deal of alarm shareholders have over the declining
supermarket (Rankin, 2014). Their idea behind the reduced dividend is to give
Lewis more firepower to turn around the chain.
Of course, with
Tesco losing their market share following the financial crisis you would easily
assume that they would be reducing dividend payments with profit margins down.
However the scale of the reduction in dividend payments is likely to further
alarm shareholders, but they need to be aware that it will take time to reverse
their underperformance of the past 3 years (Burgess, 2014).
So why did
Tesco opt to reduce its dividends on such a great scale. Besides giving more
firepower to new CEO (as mentioned above), does this lead to the
acknowledgement that Tesco’s overall company valuation has declined
significantly? Not if you acknowledge Modigliani and Miller’s (M & M) 1963
argument concerning their dividend irrelevance theory. M & M proposed that,
in a perfect capital market with no taxation or related costs, the valuation of
a company is not affected by the dividend payments. Their argument implies that
when a company has no new investments to undertake, that the funds that would
have went to investments should go to shareholders (Drake and Fabozzi, 2010:
p143). In 2015, Tesco’s cash reserves fell by £648 million, showing an
increased debt to equity ratio (Financial Times, 2015).
Tesco, have
opted to ignore the above argument, and have used cash that would have went to
shareholder’s dividends to turn the business around. This ignores the clientele
effect where shareholders have a need for regular dividend payments, and should
not be different to the dividend policies. This could lead to a negative
clientele effect where shareholders opt to sell some of their shares to meet
liabilities (Petty et al, 2011). This could come at a cost to Tesco’s
shareholders as they may have to sell shares at a cheaper rate to cover their
liabilities, as well as the process being time-consuming and implying
transaction costs.
Tesco have to
consider whether this could be an ongoing trend for the near future, and if so
consider the backlash they would receive as shareholders will be, in the short
term, losing out on payments that they should have received. If their new CEO’s
turnaround plans don’t pay off within the short to medium term then their
shareholders could attack him (verbally) at the AGM, which was the case two
years ago when they criticised then CEO Phillip Clarke for failing to stem
losses (Neate, 2012).
In my opinion,
I think that Tesco are making a wise decision, although it is to the dismay of
their shareholders. As shareholders they should know how difficult the market
has been and consider the supermarket price wars, as well as the rise of the
bargain-based retailers such as Aldi and Lidl. With a new CEO with no
experience working in the supermarket sector, you can understand shareholder
worries but I think this could be just what Tesco needs. A fresh perspective on
the company could bring ideas that were before not realised, and with the CEO’s
successful past with Unilever they know that he has a good track record. I was
surprised to see the 75 percent reduction in the interim dividend but this
could well be a one off dilemma, and normal payments could preside in the flowing
6 months. All in all, Tesco has a difficult task of restoring the supermarkets
past glory, and by investing in new ideas and with a new chief at the helm they
could well do so if they adopt new strategies and consider consumer shopping
habits in the future.
Reference List
Burgess, K.
(2014). Tesco’s shareholders must wait to
feel the love. Retrieved from: http://www.ft.com/cms/s/0/23919e2c-10e9-11e4-b116-00144feabdc0.html#axzz3ZZJn8kia
Drake, P, P.,
Fabozzi, F, J. (2010). The Basics of
Finance: An introduction to Financial Markets, Business Finance, and Portfolio
Management. New Jersey:
John Wiley & Sons Inc.
Petty, J, W.,
Titman, S., Keown, A, J., Martin, P., Martin, J, D., Burrow, M., Nguyen, H.
(2011). Financial Management: Principles and
Applications, 6th Edition. New South Wales: Pearson Higher Education.
No comments:
Post a Comment