Tesco and Dunelm defy retail gloom

Impressive updates from Tesco and Dunelm show opportunities still exist in the embattled retail sector.

A big hike in the Tesco (LSE:TSCO) dividend and an "incredible" trading update from Dunelm Group (LSE:DNLM) today combined to remind Brexit-weary investors there is life in the retail sector after all.

The near-doubling in the Tesco divi to 5.77p a share follows a landmark year in CEO Dave Lewis's five-year turnaround, with a bigger-than-expected 29% jump in annual profits.

Dunelm, meanwhile, is firing on all cylinders after the homeware retailer smashed City expectations with a 9.8% jump in store-only like-for-like sales for its third quarter.

Shares in the pair both rose by another 2% today to extend their strong starts to 2019. Tesco is now up 25% in the year to date, with the improvement at Dunelm a stunning 63% despite the uncertainty caused by Brexit and high-profile failures elsewhere on the high street.

The chain continues to reap the rewards of its updated strategy, which has included an increased focus on the core Dunelm business, as well as product innovation and the greater use of in-store technology.

It is also benefiting from growing brand awareness thanks to advertising slots on ITV's This Morning.

A soft launch of a new technology platform is also expected to take place this summer, with the intention of offering click & collect services as part of this roll-out. Only 12% of total sales currently come from Dunelm.com.

Analysts at Peel Hunt were particularly impressed with the third quarter performance, describing it as "incredible" and "outstanding" after Dunelm comfortably exceeded the broker's conservative forecast for 1% growth in store sales. The reported online growth of 32.1% compared with an estimate of 15%.

Peel Hunt added £3.2 million to its profit forecast for 2019 results, taking the figure to £121 million based on expectations that like-for-like sales growth in the current quarter will slow to 5% in-store and 20% online.

Dunelm trades on a price/earnings multiple of 16.9x 2020 earnings, although Peel Hunt thinks that the stock is still worth tucking away based on its price target of 1,000p. It also sees scope for a resumption in special dividend payments in 2020, based on strong cash generation and recent progress on its debt/earnings target.

Analyst John Stevenson said: "Overall a very strong quarter, which underlines how well improvements to the core proposition are resonating with customers. The focus on customer awareness and digital capabilities will continue to drive market share in our view."

Stifel increased its price target from 810p to 960p but JP Morgan is more cautious at 635p, noting that performance is closely tied to housing transaction levels and increasingly weighted towards bigger-ticket items.

They add: "We think that competition in the UK homewares and furniture market is growing, and we question whether the extended Dunelm/Worldstores offer provides enough inspiration and uniqueness in this context."

Competition in the supermarket sector remains fierce, although Tesco is likely to have benefited from the merger distractions facing its two biggest rivals, Sainsbury (LSE:SBRY) and Asda. 

Tesco's own high-profile acquisition of Booker is already integrated and looks to be a strategic triumph, with the cash-and-carry chain adding £196 million of profits and £79 million of synergies to Tesco's full-year operating profit of £2.2 billion.

Mr Lewis said the group had now met the vast majority of its turnaround goals, including in terms of competitiveness. One of the most significant targets has been to achieve a margin of between 3.5% and 4%, which the chain managed in the second half with a figure of 3.96%.

The continued improvement means a step-up in the recovery of the dividend, having been cut sharply in 2014 in order to give Lewis the firepower to rebuild the supermarket giant. Confidence in ongoing cash generation prompted a 92% rise in the pay-out today, with the 2.7x earnings cover expected to reduce to 2x in 2019/20.

Lewis said:

"Whilst the market remains uncertain, our performance to date is strong, leaving us well-positioned to invest in our competitiveness as we continue to celebrate 100 years of great value for customers."