UK equity managers join Buffett in backing Tesco

Equity managers at F&C and Threadneedle are among those to have been adding to Tesco ahead of today's results which showed profits had risen 12.1%.

Tesco announced its first set of interim results under new chief executive Philip Clarke this morning, reporting pre-tax profit for the 26 weeks to 27 August of £1.9bn.

Profits were up 12.1% on a year earlier, while group sales rose 8.8% to £35.5bn, although like-for-like UK sales excluding VAT and petrol fell 0.5%.

The company highlighted "excellent growth" in Europe and Asia but also "subdued demand" in the UK.

The results come a week after billionaire investor Warren Buffett was revealed to have increased his stake in the company to 3.64%.

That move was seen as a vote of confidence in new CEO Clarke, and analysts and UK fund managers issued similar endorsements ahead of the half-year results.

Phil Doel, manager of the £214m F&C UK Equity Income fund, said there are signs Clarke has stamped his authority on the company via his decision to finally close its Japanese business, the sharpening up of its US offering, and a focus on increasing the return on capital across the group.

Doel, who holds 3.6% of his portfolio in Tesco after increasing exposure following Clarke's appointment, suggested the retailer's newly-launched £500m price drop campaign illustrates the resilience of its business model.

"I think people realised it was more of a defensive stock when those price drops were announced. Tesco is in control of its business in that sense," he said.

Tesco shares have fallen 10.6% this year as investors revisited concerns over the UK consumer in the wake of a high inflation, low growth environment. The stock has outperformed J Sainsbury, which has slumped 26% over the same period, but lagged Morrisons, which has risen 6.4%.

UBS analysts upgraded the stock from neutral to buy on Tuesday, saying Tesco management was now focused on improving capital efficiency across the business.

The note said the "freakishly challenging" conditions facing the UK grocery sector in 2011, including VAT increases and fuel and food price inflation, were unlikely to be repeated in 2012.

Doel said Tesco should be able to achieve dividend growth in the region of 10%, but added the retailer was attractive from a growth as well as an income standpoint. His colleague Peter Lees, head of UK equities at F&C, holds 3% of the £203m UK Alpha fund's portfolio in the company.

"You can get the growth from the South East Asia exposure and yield from the UK business. It is the overseas businesses providing growth," said Jonathan Barber, manager of the £491m UK Monthly Income fund at Threadneedle.

Barber added to Tesco earlier in the summer, bringing an underweight position, at 1% of his portfolio, up to 1.6%.

Fixed income managers have also been buying Tesco bonds in the belief that yields offer good value: Fidelity's Ian Spreadbury has added Tesco bonds yielding 4% to his £704m Strategic Bond fund.

"Corporate bonds may continue to do badly relative to government bonds, but there will come a time when people realise companies like Tesco are not going to go bust. They are going to carry on paying the coupon", Spreadbury said.

But while Barber and Doel have been buying the equity, both remain conscious of the difficulties facing a UK retailer at a time when consumer spending remains under severe pressure.

"We will buy some more at some point, but clearly there are bad updates to come. We will build up the position every time there is an opportunity, but we remain very underweight UK domestics as a whole", said Barber.