Must read weekly preview: Tesco and Whitbread

Tesco Q1 – Thursday 18 June

Richard Hunter, Head of Markets at interactive investor, commented: The full-year results in April revealed that the Tesco (LSE:TSCO) juggernaut rumbles on, asserting its dominance of the British aisles and maintaining the yawning gap between its fortunes and those of its nearest rivals.

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In any given part of the business there are tweaks and improvements which contribute to Tesco’s overall dominance. These range from clothing to the retail Booker unit, 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.

The effect of this streamlining is twofold. It allows cost inflation to be offset, which could prove particularly important over the coming year as 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.

Indeed, 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's (15.2%) and Asda (11.5%) combined and at its highest in over a decade.

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Tesco also exceeded its guidance in free cash flow with growth of 11.8% propelling the number to £1.96 billion, leading to an upgrade in estimates for the coming year to a range of £1.5 billion to £2 billion. Alongside its focus on reducing internal costs, this leaves Tesco able to keep its powder dry in the face of any assault, and it already has plans in place to stifle the competition further. It also enables investment in the business, especially in keeping prices competitive, payment of a dividend with a projected yield of 3.2% and a recently announced share buyback programme of £750 million which, all things being equal, should be supportive to the share price.

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. Even so, the share price has reflected the group’s relentless progress, having risen by 18% over the last year and by 51% over the last two. This considerable achievement given the traditional ferocity of sector competition results in Tesco remaining the preferred play in the sector.

Whitbread Q1 – Thursday 18 June

Whitbread (LSE:WTB)’s full-year results in April contained an important update to its five-year transformation plan. In addition to previously announced plans to integrate its restaurants into Premier Inn, the group stated that it would look to reduce investment spend while releasing some capital from its property portfolio estate. Further planned savings of £250 million should then enable £2 billion of free cash flow by 2031.

Of course, the world will not stand still in the meantime and competition remains intense in the hospitality industry. Whitbread expects cost inflation of around 4% this year, even after any offsets, and consumer sentiment is currently shaky which could lessen the propensity to travel around the country.

The results revealed revenue flat at £2.9 billion, a reduction in free cash flow from £400 million to £100 million and an increase in net debt to £5.2 billion, with transformational and disposal costs responsible for some of those headwinds.

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For the moment, the Premier Inn UK business continues to do the vast majority of the heavy lifting for the group. Whitbread more recently introduced measures to fine tune profitability, such as looking at ancillary revenues whereby guests are able to pay extra for the likes of early check-in and late check-out, “Rooms with a view” and parking. Indeed, Premier Inn has become the largest hotel chain in the UK, with a 12% share of total hotel room supply. In relative terms, Premier Inn has consistently outperformed the market since the end of the pandemic and continues to do so.

Premier Inn Germany is also making all the right noises. The business contributed a profit for the first time last year, although growth has been slower than hoped. Even so, Whitbread believes Germany to be an area ripe for the picking and a source of medium-term growth. Further out, the aims are clear – by 2030, Whitbread expects adjusted pre-tax profit of £70 million emanating from what should then be 20000 rooms.

The strategy seems sound, but execution risk and a five-year timeframe until the benefits wash through are major hurdles which Whitbread will need to overcome. The shares have fallen by 19% over the last year and, while an attractive dividend yield of 4.2% pays investors to wait, any investment into Whitbread is for the long haul.