Broker snap: Jefferies encouraged by Tesco's merger talks in China

9th Aug 2013 11:12

Tesco's potential deal to merge its Chinese operations with those of China Resources Enterprise (CRE) should help the supermarket giant's transformation into a more focused, cash-generative and higher-rated grocer, according to broker Jefferies.The broker maintained its 'buy' rating and 440p target price for the stock on Friday.Tesco said that it is in talks with CRE to combine their retail operations to form a multi-format retailer in China, creating a business with sales of £10bn. CRE would have an 80% interest in the new joint venture while Tesco would take a 20% stake.Jefferies said that while there is no guarantee that the deal will complete, it is an "encouraging step" and will be strongly value-enhancing to Tesco. The broker explained that Tesco's full ownership in a "sub-scale, heavily loss-making operation" would be exchanged for an investment into a profitable vehicle benefitting from CRE's distribution and purchasing scale.Jefferies said: "We have recently outlined how we felt Tesco could fast-track its transformation from a sales growth focused business into a highly disciplined, cashflow and [returns] driven retailer by stepping up portfolio rationalisation [...]Today's announcement confirms that our assumption for rational steps to be taken by the group is a sensible one."The broker continued: "The Chinese dilution to the group's cashflow profile was probably the one that needed most urgent action (we assume that Tesco has invested a cumulative capex of at least £2.0bn between Chinese retail and malls), but we also believe a very similarly structured deal is available to the group in Turkey. Tesco's current valuation clearly ignores these opportunities."The stock was up 0.92% at 372.5p by 11:20.BC