Supermarkets titan Tesco’s (TSCO) half year results show terrific progress with its turnaround. Like-for-like sales in the core business put up growth for the seventh consecutive quarter while dividends have also resumed, albeit with a token payment.
Yet the shares are off more than 3% at 183.65p on concerns over its mega-merger with Booker (BOK) and profit-taking following a good run, with Shore Capital also noting ‘still high levels of what deem to be misplaced shorting’ of an expensive stock.
DIVIDEND RESUMPTION
Tesco’s half year results reveal rising profit margins, falling debt and a return to the dividend list after a three year hiatus. A modest 1p payment confirms Tesco has ‘left the medical ward’, to quote Shore Capital, and expresses confidence in future prospects.
‘We are continuing to make strong progress,’ thunders CEO Dave Lewis. ‘Sales are up, profits are up, cash generation continues to strengthen and net debt levels are less than half what they were when we started our turnaround three years ago.
All of this is possible because of the focus we have placed on serving shoppers a little better every day. Our offer is more competitive and more customers are shopping at Tesco.’
Pre-tax profits surged from £71m to £562m, while group sales were up 3.3% to £25.2bn, a seventh consecutive quarter of growth. Group operating margins rose to 2.7% from 2.2% last year and are on track to hit the 3.5-4% target range by 2019/20.
John Ibbotson, director of retail consultancy Retail Vision, comments: ‘After seven consecutive improvements in like-for-like sales, Tesco has finally reinstated the shareholder dividend in the clearest sign yet that the rot has been stopped.
Dave Lewis has lived up to his ‘Drastic’ nickname and achieved the delicate balancing act of increasing margins while barely raising prices.
In the current inflationary environment this is a huge feat and one of the key reasons cash-strapped customers have been returning to the retail giant in large numbers.'
Ibbotson adds: 'The combination of cheaper supplier costs and a gradual reduction of Tesco’s own operating costs have allowed the brand to increase profits in the face of a weakening market and intense competition.
It’s back to basics stuff - sticking religiously to delivering a strong food proposition, keeping prices low and improving customer service - but it works.’
BOOKER - A BANANA SKIN?
However as Russ Mould, investment director at AJ Bell, points out, ‘competition remains hot, as shown by Tesco’s emphasis on minimal price increases.’
‘It remains to be seen how much pressure Tesco is passing down the chain of suppliers in this environment (and the company makes no reference to the chicken supply investigation by two national media outlets, even though the 2013 horse meat scandal turned out to be one indication of margin and profit stress at the company).’
Mould also notes that ‘while net debt continues to rattle lower’, falling to £3.3bn from £4.4bn a year ago, Tesco ‘still has lease obligations of £7.3bn and a £2.4bn pension deficit’.
Despite these strong figures, the medium-term outlook for Tesco remains uncertain given cut-throat competition between the big players and the threat from expansionist discounters Aldi and Lidl.
Furthermore, its merger with wholesaler Booker - the Competition and Markets Authority (CMA) is due to deliver its findings soon - could prove a banana skin for management, just at the time when the turnaround has traction.
As City Index Market Analyst Ken Odeluga argues, ‘the most immediate risk for the group is that the CMA may either reject the Booker buy outright or mandate unattractive conditions’.
He adds: ‘Since we’ve always seen benefits of the combination as only somewhat better than neutral to begin with we would consequently see the impact of non-completion as moderate. But it is still easy to see why the market has remained cautious around the deal in view of the capacity for distraction.'
