Interactive Investor

Tesco upgrades forecasts as profits swell 

The UK's largest supermarket is still the one to beat after delivering strong half-year results. Our head of markets talks through the numbers and the grocer's progress on slashing costs.

4th October 2023 08:39

by Richard Hunter from interactive investor

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    Tesco (LSE:TSCO) is still the one to beat as it relentlessly delivers value to customers and shareholders alike.

    Its drive on lowering prices for customers is enabled by its sheer scale and strength, falling food inflation, and a significant cost reduction. In turn, this creates something of a virtuous circle, with more customers attracted by the likes of the group’s Aldi Price Match, Low Everyday Prices and Clubcard Prices. At the same time, it has also honed its upper end offering, with its Finest range continuing to take market share from its rivals.

    Meanwhile, the customer has a wide choice of smaller, irregular purchases or larger weekly shops through any number of delivery channels.

    While the return to physical shopping has been in evidence across retailers as a whole, Tesco has also maintained growth in its online channel, which grew by 10% and now represent 13% of overall sales, 4% higher than pre-pandemic levels. Its other routes to the till are also seeing strong growth, with large store sales growing by 9.3% over the period and convenience stores by 5.1%.

    The parallel concentration on cost reduction to enable finer pricing was illustrated by a fall of £290 million in the period, with a year end target of £600 million. In terms of headline numbers, pre-tax profit was inflated by a previous impairment charge of £626 million dropping out of the comparison, such that the figure of £1.22 billion represented an increase of 207%.

    At an adjusted operating profit level, an increase of 14% to £1.48 billion has prompted an upgrade to the full-year outlook, where Tesco now expects a result of between £2.6 billion and £2.7 billion, up from its previous guidance of £2.5 billion. The cash flow number has also been increased from the previous range of £1.4 to £1.8 billion to a new target of between £1.8 and £2 billion.

    The contributions from both Booker and Tesco Bank are also notable even though they represent a smaller proportion of overall profits. Tesco Bank, for example, saw its adjusted operating profit rise by 25% to £65 million and also paid back a special dividend to the group of £250 million, which was a significant factor in reducing the group’s overall net debt in the period, alongside the increase in cash ringing at the tills.

    The prodigious levels of cash which Tesco generates has also surfaced in shareholder returns. The group is £503 million into completing its current £750 million share buyback programme, while the dividend has been maintained in line with group procedure, with the current yield of 4.2% adding to the overall attraction of the stock.

    Of course, the supermarket sector is notable for the ferocity of competition, and the current economic headwinds facing many UK households are an additional threat to growth. Inflation may be falling but remains at elevated levels, and more generally the discounters are making their presence felt in this arena. Even so, Tesco has seen market share growth of 0.3% to 27.2%, leaving considerable and comfortable daylight between itself and its nearest competitors.

    The shares have also responded, despite a more pedestrian showing over recent months. Over the last year, the price has risen by 24%, as compared to a gain of 5.4% for the wider FTSE100, with appetite for the group’s offerings apparently undiminished for investors as well as consumers.

    As such, there should be little to trouble the group’s longstanding position as the preferred play in the sector, with the market consensus of the shares remaining at a 'strong buy'.

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