Tough times for Tesco as bottom-end profit predicted

It's tough for many families in the UK and could get tougher, and although Tesco is one of the favoured supermarkets, it is not immune. Our head of markets runs through its half-year results.

These are tough times for many, and supermarket giant Tesco (LSE:TSCO) is not alone in feeling the resultant strain.

As the pressure increases on an increasingly cost-conscious and cash-strapped consumer, the notoriously competitive sector in which Tesco operates has moved up another gear. Against that backdrop Tesco is suffering rather less than most of its competitors. Its focus on offerings such as the Aldi Price Match, Low Everyday Prices and Clubcard Prices have maintained its dominant market share.

Retail sales have grown by 3.2% on a like-for-like basis in the first half of 2022, and by 11.5% compared to pre-pandemic levels, underlining the progress which the group has made.

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There has also been some normalisation in terms of shopping habits, with a general tendency for customers to return to stores. That being said, the momentum which the pandemic provided has resulted in an increase of over 50% for online sales compared to the pre-lockdowns period. Alongside a variety of offerings for the customer ranging from Click & Collect to convenience stores to the more popular online and store visits, the group is offering something for everyone and with a sharp focus on the customer budget.

Inevitably, the wider economic backdrop is leaving its mark, and Tesco recognises the uncertainty of the remainder of the year in a cautious outlook statement. While the company is maintaining full-year profits guidance, albeit at the lower end of the previously announced range, the emerging cost-of-living crisis and the well reported pressures of inflation are taking a toll.

This is already washing through on the headline numbers. A non-cash accounting impairment charge has driven a bus through the pre-tax profit line, which declined by 64% in the 26 weeks ended 27 August. This aside, adjusted operating profit has fallen by 9.8%, reflecting reduced volumes as post-pandemic behaviour normalises, an ongoing investment in the customer offer and of course the debilitating inflationary effects.

Even so, Tesco’s cash generative abilities are shielding the group as a whole. The continued focus on cost control, where the current likelihood of savings of £1 billion are set to drop a year early, gives the company flexibility in continuing to invest. At the same time, a further slight reduction to net debt has been made and shareholder returns are being increased. Apart from an ongoing share buyback programme, of which £450 million of the previously announced £750 million has already been implemented in the current stage, there has been a significant increase to the dividend. This places the projected yield at around 5.5%, which is a punchy return even in a generally rising interest rate – and therefore savings rate – environment.

Fuel sales have also boosted revenues, and the fact that the customer may now be retrenching is also reflected by an increase of 13% of sales in its “Finest” range, suggesting less of a propensity for customers to eat out, with Tesco again being there to offer the customer an alternative. The group’s sheer scale has also enabled price increases to be kept to a relative minimum, while its long-established supplier relationships ease some of the pressure as compared to many of its rivals.

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However, Tesco is not immune from the more recent deterioration in economic conditions, and the sector as a whole has been under both trading and share price pressure. Tesco shares have declined over the last year by 17%, as compared to a marginal gain of just 0.1% for the wider FTSE100. This has in turn undone some of the previous progress, with the share price flat over the last two years.

Even so, as the economic challenges mount, investors will continue to look towards those companies with the best chance of emerging on the other side in good shape. The market consensus of the shares as "buy" reflects confidence in such prospects.