Tuesday, October 9, 2007

Tuesday Talking Points Memo

Billionaire Investor Warren Buffet is Betting Big on Tesco and the Success of its Fresh & Easy Neighborhood Markets in the U.S.
Warren Buffet is pictured above with his close friend Microsoft founder Bill Gates. Buffet, the world's second richest person (Gates is number one), is giving his $40-plus billion fortune to Gate's foundation to be used for global good.
Warren Buffet, America's most famous investor and the second richest man in the world, has been buying an increasing amount of stock in UK-based mega-retailer Tesco (parent company of Fresh & Easy Neighborhood Markets in the U.S.) over the past year. Buffet's Berkshire Hathaway investment firm now holds about 3% ownership in Tesco, an investment valued at a little over $1 billion. Buffet currently holds about 230 million shares.

Omaha, Nebraska-based Buffet, know as "The Oracle of Omaha" for his magic touch as a long-term investor, began buying Tesco stock last year at about the time the retailer announced it was planning to enter the U.S. retail food market with its upscale, convenience-type food stores called Fresh & Easy Neighborhood Markets. The Fresh & Easy format features stores of about 10,000 square-feet which specialize in fresh, prepared foods, specialty groceries and related upscale offerings.
The first Fresh & Easy markets are to open in Southern California on November 8, 2007, with other stores to follow in Arizona and Las Vegas, Nevada before the end of the year. Tesco currently says it has at least 100 Fresh & Easy stores in the pipeline, either under construction or in the planning stage. More will follow that, first throughout the Western U.S. and then elsewhere, according to Tesco. It's estimated Tesco could have 1,000 Fresh & Easy stores in the U.S. in 10-12 years with estimated sales of over $7 billion.

Having Buffet betting on Tesco and the Fresh & Easy format should be a vote of confidence to the retailer--and something competing supermarket chains and other food retailers should keep their eyes on. Buffet is a long-term investor and seldom if ever picks losers. His fund, Berkshire Hathaway, turned in a 29% profit last year. Fund profits in 2006 totaled $11 billion, up from $8.5 billion in 2005. The homespun but savvy Buffet tends to turn in similar profits most years. He still works out of his Omaha office with partner Charlie Munger and a small staff. At 76 Buffet is the junior of the two. Munger is in his early 80's.

Wall Street is watching Tesco's upcoming launch of its Fresh & Easy stores and also has taken notice of Buffet's substantial investment in Tesco. For example, right after Buffet's announced in March of this year that he was buying another substantial chunk of Tesco shares, the retailer's stock went up by 5%.
Patricia Baker, a supermarket industry analyst at Merill Lynch believes Tesco's Fresh & Easy format will be a "formidable competitor to U.S. supermarkets." She recently told her investors she believes Safeway Stores, Inc. will be the most susceptible to a drop in share price because of Tesco's focus on the Western U.S. where Safeway has major operations. About 30% of Safeway stores are located in the Western U.S. Safeway's stock has dropped about 3.5% this year, even as the Standard & Poor's 500 Food Retail Index has risen 8.1%. Baker may be on to something although it's important to note that no Fresh & Easy stores have yet to open.

Safeway isn't sitting still though. Although it doesn't have Buffet as a major investor, CEO Steve Burd recently said the chain has studied what Tesco is doing with the Fresh & Easy format inside and out--and is tracking where their stores will be. Burd says Safeway is prepared to enter the market in the Western U.S. with a similar small format, convenience-type store should they deem the Fresh & Easy stores a success in the market. If they do Burd says Safeway can do it better since they are a known brand name in the U.S.

Meanwhile "The Oracle of Omaha" Buffet is sitting on ownership of 3% of Tesco, which had 2006 sales of $85.5 billion and is the world's third largest retailer. Being a long-term, value investor Buffet is more likely to buy more Tesco stock rather then sell anytime soon. In addition to its Fresh & Easy Neighborhood Market initiative in the U.S. Tesco is building similar stores all over Europe and East Asia. Additionally, the retailer operates huge superstores throughout the world, selling everything from food to clothes, and everything in between. It's the grocery market share leader in the UK and a major player globally.

We're told Buffet is watching the upcoming Fresh & Easy store launch closely just like Wall Street is. And Wall Street is watching Buffet to see if he increases his holdings in Tesco. Buffet spends much time in California (Berkshire owns California-based See's Candies among the many firms in its portfolio) and we expect him to drop in and check out a Fresh & Easy store in Southern California when they start opening next month.
Perhaps if he likes what he sees he will increase his stake in Tesco? We aren't sure however if Buffet will personally go for Fresh & Easy's upscale prepared foods offerings. Among the companies Berkshire Hathaway owns is the Dairy Queen hamburger chain and Buffet is know for eating at a Dairy Queen when in California. A note to Fresh & Easy management: Buffet's favorite beverage is Cherry Coke. We suggest making sure you have it in the cold case when the Southern California stores open in a month. It's good investor relations.

You can read Warren Buffet's autobiography here.
You can view Buffet's Berkshire Hathaway company website here.
You can view Tesco's website here.
You can view the Fresh & Easy Neighborhood Markets Website here.

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