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Where next for Tesco shares as bumper profits due?

Shares in the supermarket chain are up 17% this year but inflation is an issue

Tesco is expected to post its biggest profits for eight years on Wednesday. The supermarket giant revealed at its third-quarter trading statement in January that it enjoyed stronger than expected sales and analysts are now expecting bumper full-year profits.

Retail operating profits are expected to be slightly above the top-end of the £2.5bn to £2.6bn guidance management previously gave analysts. Meanwhile, banking operating profits are anticipated to be between £160m and £200m due to more benevolent economic forecasts on the company’s credit losses provision.

This comes against soft comparative figures last year, when profits fell by a fifth after Tesco returned £585m in business rates relief to the government.

Tesco benefits from Covid-19 restrictions relaxing

Sales at the banking division are expected to be up over a third due to the full ownership of Tesco Underwriting, while results are also expected to receive a boost from the easing of Covid restrictions.

“We are delighted that we were able to help our customers have a great Christmas,” chief executive Ken Murphy told investors in January. “Despite growing cost pressures and supply chain challenges in the industry, we continued to invest to protect availability, doubled down on our commitment to deliver great value and offered our strongest ever festive range.

“This put us in a strong position to meet customers’ needs as, once again, COVID-19 led to a greater focus on celebrating at home. As a result, we outperformed the market, growing market share and strengthening our value position.”

Inflation pain for supermarket sector

Inflation is likely to be a thorn in Tesco’s side, however, and the supermarket chain will be under pressure to maintain or cut prices for consumers as they face the biggest rise in living costs for 60 years. Indeed, some industry experts expect a supermarket price war to ensue, as Tesco competes with Aldi and its rivals are forced to keep up.

Nevertheless, analysts think that Tesco’s scale, with its 4,000 stores, gives it an advantage over its rivals and should afford it some pricing power, according to analysts at AJ Bell. It has been growing market share from the likes of Morrison’s and Sainsbury’s and currently boasts a 27.4% share of the grocery market, according to the latest research from Kantar – its biggest growth in market share for four years.

“At a time when inflation is a key concern, and customers will start to trade down or even buy less, this could be a useful part of Tesco’s armoury when it comes to driving profits and cash flow and protecting profit margins,” said Danni Hewson, analyst at AJ Bell.

Meanwhile, analysts at broker Shore Capital sound a note of caution regarding inflation and increased staffing costs. “Holding [our] forecasts will be a good result to us, as the amalgam of essentials inflation, rising NIC [national insurance contributions] and the turn of the interest rate cycle rest against the increase in the National Living Wage,” they said in a note.

At 274.64p, Tesco shares are up 17% this year but off their five-year high of 303p seen in January. As such, they are still a long-term buy, although it may be worth taking some profits post the results.

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