The Rotten Apple Test: How To Tell If A Grocery Store Chain Is Going Down The Tubes

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The number of problem long investments in my portfolio doubled overnight – from one to two. (We have some small problem longs and some large longs with more minor problems – and some problem shorts but only two largish positions that are doing poorly.)

The treacherous two are the (much discussed) Bank of America long and the (less discussed) Tesco. Bank of America is a bank – therefore highly levered – and therefore total disasters can’t ever be discounted. But Tesco is a grocer with a seemingly impregnable position in the UK and some positions elsewhere that may or may not be fine. It is hard to see how you compete with Tesco in its core business – and hence it is pretty hard to see how they get into real trouble. They have debt (driven by the demands of investors during the last cycle to “sweat the balance sheet” but the debt should not be problematic and the repayments are fairly rapid.)

I thought Tesco was my “safe” long. The relatively safety made the position bigger!


On Tesco, I was sceptical of their expansion into the United States. Grocers (indeed retailers in general) have a poor record of crossing borders – there are plenty of cultural differences.

More to the point it is fairly easy to open up in competition in the US – there are vacant big-boxes everywhere and soon to be more – but it is very hard to open up in competition in the built-up cities of the UK. The UK is thus naturally a good business (hard to compete with) and the US less so. [Contra: I guess that is why they open in the US – because they can get sites…]

But when I revealed the position one of my regular correspondents (and obviously smarter than me) admonished me. He thought the American positions would be fine but the UK was going to be problematic – he thought margin declines could be nasty. And that is how it looks right now – the US has very good sales growth – the UK rapidly falling sales growth (a very bad second derivative) and declining margins to boot.

Margins may be the end of this story – but maybe there is something else. After all the competing retailers did well over Christmas – the problems look Tesco specific.

So here is a request for comments. When I was last in the UK (both recent trips) I did not step out of the international city of London. Oxford Street is visibly doing quite well. But the UK is not. My friends with businesses over the UK describe the city as a cocoon in which you can comfortably shop and see no problems with the world. Go to business parks in Edinburgh once built for grand financial institutions and it looks different.

So here is a request – and it is a request for my (relatively few) UK readers outside London. What is going on at Tesco and Sainsbury in places like Leeds or any other major regional city in the UK? Is there a reason why the problems appear Tesco specific? Is Tesco deliberately going down market (they appear to be in recent promotional videos).

My hopeful request to readers is for someone to conduct an “apple freshness test” in a regional city. For this test you buy an apple from each of the local grocers on the same day and leave them on the shelf to see the order in which they rot to the point you would not eat them. Twelve days is generally pretty good – it means the supply chain is fast and efficient. Eight days less so. The grocer that loses the apple freshness test eventually loses the reputation for fresh food and will (inevitably) lose margins and profits. This is something that happens imperceptibly – but women (and they are mostly women in this case) are very good subjective judges of where to shop.

The “apple freshness test” is the core here. The company says that at the “heart” of what they need to do is fresh foods. Fresh foods is only partly about what happens in the store. To be fresh they need to deal with the chain.

Hoping for help from my readers.


It is a small (meaning worthless) consolation that the two stocks on which I am suffering are the ones Warren Buffett has been buying. I am losing money in good company – but they are losses just the same. (Unlike him though I have some winning short-sales…)