Tesco LON:TSCO, the national food retailer will publish its latest set of Interim Results next Wednesday (4th October).
The UK’s biggest supermarket (by volume of trade) which shifted over GBP60bn of product in its last financial year and now accounts for over 27% of the UK supermarket sector, might be the biggest, but consumers rate newcomer Aldi more highly, which might cause a problem for the current king of the hill in the next few years.
Tesco has been a profit-monster for some time, but in its last results published in April the retailer bemoaned the fact that it had been “an incredibly tough year” with “unprecedented levels of inflation” and conceded that this was felt keenly across the nation as the cost-of-living crisis hit household budgets like train.
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The retailer only made GBP1bn profit before tax, down from GBP2bn in 2021/22, a sad decline that the company’s CEO, Ken Murphy said was a result of the higher prices it has had to pay its suppliers and the discounting it had made on items in its stores.
In January, the then Tesco chairman, John Allan, blamed food producers for the cost-of-living crisis, not the retailers, saying that food manufacturers had been using inflation as a cover to price gouge, and unfortunately Tesco and the other retailers were caught in the uncomfortable bind of being forced to pass on “illegitimate price hikes” to consumers.
He continued saying that Tesco was trying its hardest to keep down costs and “challenging” the price rises and challenged these manufacturers by pulling the nation’s favourite baked bean, Heinz, off Tesco shelves (obviously the company sold a lot more ‘own brand’ products during this period) along with a basket of other items from Kraft Foods NASDAQ:KHC for a short while.
Allen stepped down as chairman in May and also lost his job at Barratt Homes LON:BDEV after accusations of sexual misconduct, and was replaced by Gerry Murphy from Tate & Lyle LON:TATE in July.
Tesco “doing very well” during the cost of living crisis
The UK’s biggest retailer saw sales rise 7.2% to GBP65.7bn in the year to 25th February, including a 3.3% increase at its UK supermarkets, but said it had sold fewer items as shoppers were more circumspect in their buys, to manage household budgets under pressure from price rises.
However, the grocer was feeling quite boosterish as to it future prospects, as retail prices remain high and retail options on the high street decline. The company hopes to bring in between GBP1.4bn and GBP1.8bn in profit in the next financial year.
Although profits halved last time around, GBP1bn is still a lot of cheddar cheese, and the retailer has attracted the ire of civil society. Sue Davies, head of food policy at consumer body Which?, said the results showed Tesco was “doing very well” while the cost of living crisis is causing many of its customers to struggle.
The Unions were even more scathing, with Unite general secretary Sharon Graham saying: “Tesco’s profits are another example of excessive profiteering fired up by astonishing corporate greed. It’s this rampant profiteering, which is driving inflation, and cranking up the cost of living crisis for workers and their families.”
She continued: “How can it be that at a time when millions are struggling to feed their families Britain’s biggest supermarket is profiteering as never before. […] Frankly, the latest results are obscene.”
Dividends and a share buy back scheme
But shareholders haven’t been complaining. Tesco announced a final dividend for 2022/23 of 7.05p/share, taking the full-year dividend to 10.9p/share, in line with 2021/22’s full-year dividend. The company also initiated a share buy-back scheme in October 2021, buying over GBP1bn of shares since April 2022, and then doubled-down with another GBP750m offer over the next year. The company said: “We see the buyback programme as an ongoing and critical driver of shareholder returns. Reflecting the strength of our balance sheet and our confidence in delivering strong future cash flows…”
Although in a seemingly unassailable place, Tesco, just like Dushane Hill in crime drama Top Boy, has got to the top of the pile and will do anything to stay there. The biggest threat to Tesco is not from the established players like Sainsbury’s LON:SBRY or Asda who are happy with their own turf and the money they can make from it; but up and coming players like Aldi and Lidl, who have developed the ‘stack ‘em high, sell ‘em cheap’ retail model that WM Morrison [LON:MRW] started out with at the country’s first ‘supermarket’ in Bradford market.
The battle with the discounters
The competition at the bottom is fierce, and with Aldi revealing its sales were up by nearly GBP2bn to GBP15.5bn yesterday and strutting about the manor claiming the cost-of-living crisis had changed shopping habits for good, Tesco reacted this morning (27th September) by locking more than 1,000 prices until 2024 as part of its plan to deliver “great value” and help shoppers cope with the cost-of-living crisis. The supermarket giant will also cut prices on hundreds of items and apply Aldi Price Match to hundreds more products. The battle with the discounters will rumble on into 2024.Tesco opened trading today at 270.29p, but as news of the price lock emerged, had fallen to 266.5p within the first three hours of trading. The company has offered a year-to-date return of 18% and a one-year return of 25.1% and has a market capitalisation of GBP19.2bn.
The City seems to be quite happy with Tesco, with Barclays upping its target price for Tesco from 320p to 325p last month. The City expects a robust performance next week with Barclays predicting that the UK like-for-like growth will remain relatively steady at 8.8%, in comparison to the 9% growth recorded in the initial quarter. Additionally, Barclays expects a 10.2% increase in retail earnings before interest (EBIT).
Tesco ‘Overweight’ rating
As a postscript, Barclays added that Tesco should upgrade its guidance on full-year earnings and cash flow, and the bank, despite being cool on the retail sector generally, is backing its own calls by remaining ‘Overweight’ in Tesco (like some of Tesco’s customers were as a result of its historic discounting of junk food and meal deals, something the supermarket said it is addressing by promoting healthy eating options).
At the beginning of the year, The Armchair Trader said that Tesco shares were looking good value at 248.4p trading at the time on a forward price-to-earnings ratio of around 11.5x when the FTSE100 was flirting with an all-time high. The company is now trading at 12x, which is still behind the FTSE100 average of 14x. There may be some room to move up.
However, the ‘Aldi-effect’ is significant for Tesco, in that it is stuck in a race to the bottom. Giles Hurley Aldi’s CEO said: “What we’re seeing is a new generation of savvy shoppers who’ve turned their back on traditional, full-price supermarkets in favour of transparent, low prices.”
Aldi might ‘stack ‘em high’, but with the ‘sell ‘em cheap’ mentality it only had a profit margin of 1.2% in 2022. In an attempt to extinguish the competition, Tesco has also tried to compete on price, which it can do, but isn’t in its comfort zone and has seen its profit margin fall to 3.8% a drop of 54bps from this time last year. The other option that Tesco is following is to be on everyone in the UK’s doorstep, and is planning on opening another 500 outlets, to take its total to over 1,500. I can understand the rationale, but building new supermarkets is an expensive undertaking and even a giant like Tesco can spread itself too thin.
