A challenging Q1 as expected, but Tesco juggernaut rolls on

Strong comparatives from the previous year and some early effects from the Middle East conflict have shaved some strength from the numbers, but growth nonetheless remains intact.

Tesco (LSE:TSCO) considers that it has been a good start to the year, and has maintained its outlook for the full year of adjusted operating profit in a range of £3 to £3.3 billion and free cash flow between £1.5 and £2 billion. The £750 million share buyback programme is ongoing, while a dividend yield of 3.2% lends further support to both investors as well as the underlying share price.

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At the group level, the numbers are largely in line with estimates since some weakening – by Tesco’s standards – had been expected. Revenues rose by 2.3% to £16.83 billion, with like-for-like sales (LFL) posting a 1% increase. By far the largest unit, the UK, saw Food sales growth of 2.6% but the range of the group’s offering is not limited to the more cost-conscious consumer. More recently Tesco has honed its upper end offering, and the Finest range saw growth of 9%, and 29% over two years, reflecting a unit going from strength to strength.

Online sales grew by 8.9% in the period, while Tesco’s mobile service now has almost six million customers. The wholesale unit Booker remains a slight blot on the landscape, where LFL sales fell by 3.2% where the loss of a contract impacted. In addition, tobacco sales are falling away sharply and look unlikely to recover, having dropped by 9.7% over the last year and by 17.2% over the last two. Nonetheless, the unit contributes 13% of overall sales, which enables Tesco comfortably to pick up this slack elsewhere.

Indeed, in any given part of the business, there are tweaks and improvements which contribute to Tesco’s overall dominance. These range from clothing to delivery options such as Whoosh to a broader offering at the higher end, and online growth to food prices. Much of this has been made possible by the group’s “Save to Invest” programme, which has delivered more than £2.2 billion of cost savings over the last four years including around £535 million last year, with a further £500 million planned for the forthcoming period.

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The effect of this streamlining is twofold. It allows cost inflation to be offset, which could prove particularly important over the coming year if the inflationary effects of the US/Iran conflict wash through, as well as keeping prices low for consumers. The group’s sheer scale feeds its appetite for lowering prices for customers through the likes of Aldi Price Match, Low Everyday Prices and Clubcard Prices, such that the significant cost reduction creates something of a virtuous circle. As such, the ongoing battle is still for Tesco to lose rather than its rivals to win.

Moreover, in the recent past and try as they may, other supermarkets have tended to take market share from each other rather than from Tesco. Its current share of 28.2% is more than that of its two nearest rivals, Sainsbury (J) (LSE:SBRY) (15.2%) and Asda (11.5%) combined and at its highest in over a decade.

Of course, any progress comes alongside not only ferocious competition but also pressure on increased costs, while maintaining lower prices also comes with an inevitable impact on margins and revenues. In addition, Tesco’s advances inevitably lead to progressively higher expectations, which in turn lessens the likelihood of positive shocks for investors, as evidenced by the tepid reaction to this update. 

Even so, the share price has reflected the group’s relentless progress, having risen by 15% over the last year, as compared to a gain of 18.8% for the wider FTSE 100. The shares have spiked by 48% over the last two years and by 84% over the last three, which is a considerable achievement given the traditional ferocity of sector competition. Regardless of any external pressure, however, two points are firmly intact. The market consensus of the shares as a buy shows no signs of weakening, nor indeed does the view that Tesco is comfortably the preferred play in the sector.