Tesco share price: a renaissance for the supermarket?

Tesco looks to be back on its feet three years after an accounting scandal plunged the UK’s biggest supermarket into darkness. With profit back on track, the dividend reinstated and the Booker Group merger completed, is there light at the end of the tunnel for Tesco and its share price?

Tesco
Source: Bloomberg

‘Serving Britain’s shoppers a little better every day,’ – Tesco’s core purpose.

Is Tesco enjoying something of a renaissance? Just three years ago in early 2015, the UK’s largest supermarket reported its worst financial performance in its near 100-year history following an accounting scandal. Tesco had sunk to a £6.4 billion loss, its share price plunged to its lowest level this side of the millennium and its board became embroiled in investigations that eradicated investor’s trust in what has historically been one of the jewels of London’s stock market.

Facts about Tesco:

  • Tesco was founded in 1919 as a trading business and opened its first store in 1929
  • Expanded internationally in the 1990s and 2000s, launched UK online business in 2000
  • Outside of the UK, Tesco is active in Ireland, Czech Republic, Hungary, Poland, Slovakia, Malaysia and Thailand, as well as joint ventures in China and India.
  • Tesco’s worldwide operations employ 460,000 staff in over 6800 stores
  • Tesco has over 3500 of those stores in the UK, where it employs 330,000 members of staff
  • 79 million shopping trips completed in Tesco each week, 52 million of which are in the UK
  • Feeds data from its Clubcard loyalty scheme to its marketing insight business, Dunnhumby
  • Has over 38 million Clubcard members, of which 16 million are in the UK
  • In addition to the retail business, the firm also owns units like Tesco Mobile and Tesco Bank
  • Tesco Mobile is the fifth biggest UK operator with almost five million customers
  • Tesco Bank started out in 1997 and now has 5.6 million customers

Fast forward three years and Tesco, led by chief executive Dave Lewis, is close to drawing a line under the saga that has built up over a tumultuous few years. Tesco have even embarked on its next big phase of growth, following its £3.7 billion acquisition of the UK’s largest food wholesaler, Booker Group.

Tesco accounting scandal: a brief overview

The supermarket hit trouble back in 2014 when Tesco admitted it had overstated its profit expectations after recognising income too early and delaying the recognition of costs, to the tune of over £250 million. Tesco had already issued a profit warning and said it was going to slash its dividend less than one month earlier.

That financial year, which ended in February 2015, Tesco’s trading profit for the year more than halved, it sank to its biggest-ever pre-tax loss and the dividend was scrapped, leaving shareholders with a small interim payout. Shares were pushed lower throughout 2015, and by December, the revelations had plunged Tesco shares to their lowest level since 1997.

Lewis, who joined as CEO in September 2014, started implementing changes with the hope of achieving three goals: to recover Tesco’s competitiveness in the UK, to protect and strengthen the balance sheet, and to begin the long journey back to building trust and transparency into the business and brand. This was followed up with more detailed targets being laid out two years later in 2016, which aimed to improve margins, cut costs, improve cash flow and streamline its property portfolio.

Former Tesco executives face re-trial

While Lewis and the current Tesco management team continue to get the business back to its former glory, the three former Tesco executives accused of mishandling the accounting scandal are to face a re-trial in the near future after one of the defendants suffered a heart attack in February when the trial was drawing to a close.

Tesco’s former UK finance director Carl Rogberg, UK managing director Christopher Bush and UK food commercial director John Scouler are accused of failing to correct the inaccurate financial figures that were published to the market. A date for the re-trial is to be announced shortly by the Serious Fraud Office.

Tesco financial results get back on track after three years of hard work

‘The progress Tesco has made against the three turnaround priorities set out in October 2014 has stabilised the Tesco group. Tesco is more competitive, its balance sheet is more secure, and it is rebuilding trust and transparency in its brand. Tesco has made sustained improvements in price competiveness, availability, quality and service,’ – Dave Lewis on Tesco’s interim results for 2018.

Tesco’s latest annual results suggest the company is firmly back on track after profit exceeded £1 billion for the first time since 2014. Profit growth was substantial, soaring to just shy of £1.3 billion from just £145 million the year before. However, Tesco still has a lot to do to fully recover; revenue and retail cash generation are both still considerably lower than it was before the firm was derailed in its 2015 financial year, and profit is still trailing 43% from their 2014 levels. Still, the progress Tesco is making is evident and the latest annual results beat the company’s own guidance, as well as analyst expectations.

(in £, millions)
2014 2015 2016 2017 2018
Revenue
63,557 56,925 53,933 55,917 57,491
Operating profit (loss)
2631 (5750) 1072 1017 1837
Pre-tax profit (loss)
2259 (6334) 202 145 1298
Retail cash generation
4607 1860 2581 2278 2773
Net debt
6597 8481 5110 3729 2625
Dividend
14.76p 1.16p 0p 0p 3p


Shareholders will take some additional comfort from Tesco reinstating its dividend after two-and-a-half years, as well as the considerable reduction in net debt levels over the past three years. Furthermore, Tesco has significantly reduced its pension deficit and lease commitments, both of which are excluded from its net debt figures. Lease commitments at the end of the year stood at £6.9 billion compared to £7.4 billion a year earlier, while the pension deficit was slashed by more than half to £2.7 billion from £5.5 billion, lowering the supermarket’s total indebtedness.

Having reinstated the dividend last November following its interim results, Tesco’s goal is to have a dividend cover of two times earnings per share (EPS) over the medium term, and will be broadly weighted one third for the interim payout to two-thirds for the final payout. For context, EPS was 12.12p in the recently-ended financial year versus just 0.81p the year before.

Tesco’s like-for-like sales performance finds momentum

Tesco’s like-for-like sales in the UK have found momentum after growing for nine consecutive quarters, supporting the view that Tesco has reached a turning point. Growth peaked in the final quarter of the last financial year to put the supermarket on firm footing for the next 12 months. Overall, Tesco attracted over 260,000 more customers to its UK stores than the year before.

After refining its product range, overhauling prices and streamlining its portfolio by selling off assets, Tesco’s same store sales in the UK rose 2.2% in the recently-ended financial year largely thanks to food sales, which have continued to outperform non-food sales.

Tesco remains on track to deliver targets outlined in October 2016

Tesco is working toward three targets it set back in 2016 that it wants to achieve by the close of the financial year due to end in early 2020. The three targets were to reduce operating costs by £1.5 billion, generate £9 billion in cumulative retail cash and to get its operating margin up to 3.5% to 4%.

The grocer’s progress so far has instilled confidence that Tesco can deliver. With two financial years left to go, Tesco has locked-in about £820 million worth of cost savings, raised its margin to 2.9% (from 2.3% the year before) and remains on course to hit its cash flow target having generated retail cash of £2.8 billion last year and £2.3 billion the year before.

Tesco analyst consensus: revenue and profit to climb this year and next

Analysts are expecting Tesco to grow revenue and profit over the next two years. According to the supermarket’s website, analysts are forecasting the company will deliver revenue of £58.4 billion in the current financial year to produce an adjusted operating profit of £1.79 billion and a pre-tax profit of £1.35 billion.

In the financial year to end in 2020, analysts expect Tesco to deliver revenue of £60.8 billion, an adjusted operating profit of £2.02 billion and a pre-tax profit of £1.61 billion.

UK grocery sales: what is the market share of the big supermarkets? 

The latest grocery sales data from Kantar Worldpanel revealed that Tesco managed to grow sales 2.4% in the 12 weeks to 25 March to hold its market share steady at 27.6%, the first time it has held its share since December 2016. Morrisons matched that sales growth to make the pair the two fastest growing supermarkets out of the ‘Big Four’.

Meanwhile, Walmart's Asda shed market share, despite reporting higher volumes, while Sainsbury's lost the most market share out of the Big Four despite growing sales, partly because the grocer has continued its move away from promotions.

Online sales in the UK grocery sector have continued to grow lately but at a slower rate, which persisted in the latest 12-week period. Online sales rose 3.6% year-on-year and Ocado Group, the purest online player in the space, has continued to outperform the average by growing sales 9.3% in the period, which resulted in no change in its market share.

One of the biggest challenges for the big supermarkets has been the rise of discount retailers, particularly German outlets Aldi and Lidl, which have both stolen substantial market share over recent years. Although Tesco and the other big stores have managed to slow the loss to these newer rivals, Aldi and Lidl’s share of the UK grocery market has never been bigger, and the pair continue to grow sales at a faster rate with Aldi sales up 10.7% in the 12-week period, while Lidl sales rose 10.3%.

Kantar Worldpanel reported that the disruption from Aldi and Lidl is still substantial as both are still opening up new stores, adding that over 63% of all households visited at least one of the two retailers in the most recent 12-week period.

Looking at the wider picture, grocery inflation stands at 2.5% as of the last report and prices have consistently risen since late 2016, snapping a long period of deflation in prices since September 2014. According to Kantar Worldpanel, the products that are rising the fastest at present include butter, fresh lamb, fresh fish and fresh pork, while prices are deflating in only a ‘few markets’ like laundry detergents and ambient cooking sauces.

Learn more about how the UK retail sector is performing and the trading opportunities that come with it.

How have Tesco’s rivals performed: Sainsbury’s and Morrisons

Tesco is not the only market to have turned a corner in recent years. Morrison’s latest results for the year that ended in early February showed that the country’s fourth largest supermarket grew revenue by 5.8% to £17.3 billion, like-for-like sales by 2.8% and pre-tax profit grew by 17% to £380 million, prompting the company to step-up returns.

Shareholders saw the dividend raised over 12% to 6.09p, and an additional special dividend of 4p to see the total payout for the year almost double to 10.09p. Meanwhile, net debt was cut by over £200 million to take its net debt to £973 million, below its £1 billion target.

Interestingly, Morrisons is being led by two former Tesco executives. Morrisons’ chairman, Andrew Higginson, and chief executive David Potts both joined in 2015, having previously chalked up almost 55 years between them at Tesco during their earlier career. Their influence has been seen as instrumental for Morrisons as the company’s performance has improved significantly since they joined in the wake of the company reporting a hefty £792 million annual pre-tax loss.

Morrisons has focused on rebuilding itself as a low-priced chain and has struck innovative deals to supply convience store chain McColl's nationwide and to sell its products through Amazon's Prime service while installing Amazon’s click and collect lockers in its stores. Selling to other stores is of growing importance for Morrisons (as it is for Tesco), with wholesale supply sales set to hit £700 million in the current year and eventually topping £1 billion.

As for Sainsbury’s, investors have a little longer to wait for annual results. However, the country’s second largest supermarket put in a record performance over the Christmas period and said in January, releasing its third quarter (Q3) results, that annual underlying pre-tax profit would be ‘moderately ahead’ of the market consensus of £559 million, suggesting there is a good chance profit will fall from the £581 million profit delivered in the last financial year.

While Tesco has expanded into wholesale, Sainsbury’s has doubled-down on its retail offering through its acquisition of Argos. Sainsbury’s has been pleased with the performance of the Argos stores installed inside its supermarkets and the unit delivered a record performance in last year’s Black Friday sales event. Argos currently accounts for about 20% of Sainsbury’s total revenue.

Read more about Sainsbury's aquisition of Argos.

The reason that Sainsbury’s upped its expectations for the full year was because it expects to reap more reward from Argos than previously thought, stating synergies would be up to 30% higher than first guided, and because it is cutting more costs. Much like Tesco, Sainsbury’s is stripping out expenditure to improve profitability and both have cut thousands of jobs as a result.

Important dates: when do Sainsbury’s and Morrisons report next?

Sainsbury’s financial year ends in mid-March and annual results will be released on 2 May. That will be followed by a trading update for Q1 of the new financial year on 4 July and interim results on 8 November.

Morrisons will release a Q1 trading update on 10 May and release its interim results for the first half on 13 September. Following the recently-ended financial year, the supermarket’s shares will go ex-dividend on 24 May and hold its annual general meeting on 14 June.

Meanwhile, Ocado Group will release interim results on 10 July.

Tesco and Booker Group: harmonising retail and wholesale

‘This merger is about growth, bringing together our complementary retail and wholesale skills to create the UK’s leading food business. This opens up new opportunities to provide food wherever it is prepared or eaten – “in home” or “out of home” – and will benefit our customers, suppliers, colleagues and shareholders,’ – Tesco chief executive Dave Lewis, February 2018.

Booker Group is the largest food wholesaler in the UK selling to small and independent businesses like convenience stores, grocers, leisure outlets, restaurants and pubs. It took over a year for Tesco to complete the deal following a lengthy approval process and the merger has seen Booker Group’s chief executive, Charles Wilson, takeover as the CEO of Tesco’s retail and wholesale operations in the UK and Ireland.

Facts about Booker Group:

  1. Booker was formed in 1835 and became publicly listed in 1933
  2. Iceland Group bought Booker in 2000 and renamed it Big Food Group
  3. It was then bought and split up by Giant Topco, leaving it as a cash and carry
  4. Modern-day Booker formed in 2007 when Giant Topco reversed into Blueheath Holdings
  5. Booker moved from London’s AIM to the Main Market in 2009
  6. Owns fascias for Premier, Budgens, Londis and Family Shopper convenience stores, allowing retail customers to trade under its brands
  7. Booker has a tiny wholesale arm in India, which accounts for less than 1% of revenue
  8. Booker sells to 117,000 independent retailers, 569,000 digital customers, 441,000 caterers and 641,000 small businesses
  9. Currently stocks over 18,000 product lines and has 198 branches
  10. Booker competes with Bestway, Spar, Nisa, Costco, Today’s, Landmark, Bidfood, Conviviality and Brakes
  11. Store sales totalled £3 billion in the 2017 financial year, while sales delivered to customers amounted to £2.3 billion
  12. Booker shareholders own about 16% of Tesco following the merger

With Tesco back on its feet and Booker Group primed to provide the next step-up in growth, shareholders have reason to be optimistic going forward. Having said that, Tesco faced notable opposition to the deal from some shareholders who argued that the firm was still too fragile to be pursuing such a large deal.

Learn more about what activist investors are and how they work.

Tesco’s argument comes down to growth as its core business is stable, while Booker has growth opportunities spawning off the back of the rising popularity of eating-out among consumers. Tesco sees the deal as a way of bringing together the best of both worlds, retail and wholesale, and believes it is catching on to a long-term trend of people eating-out more, whether that be in a restaurant or grabbing a pasty on your lunchbreak.  

Tesco shareholders, including Schroders and Sandell Asset Management, questioned the deal, and shareholder advisory firms, like Glass Lewis and ISS, suggested Booker shareholders turn down Tesco’s offer. Tesco’s meeting saw 85% of the shareholder vote in favour of the deal and Booker’s approval was a touch lower at 84%. 

Read our guide to activist investors and how to use them in your trading strategy.

The most immediate challenge for Lewis and his team is to prove the naysayers wrong and show the Booker deal was the right move. While the latest results will go a long way to instilling confidence, Tesco and its share price have a long way to go if the supermarket is to make a full comeback.

How is Booker Group performing?

Although it still needs auditing, Tesco said Booker’s underlying operating profit for the financial year to the end of March was £195 million. That would be up from £176 million in the 2017 financial year, £153 million in 2016 and £140 million in 2015. Booker is thought to have £120 million in net cash at present.

What synergies are Tesco and Booker Group looking for?

Tesco is hoping to reduce its cost base by leveraging synergies with Booker Group and is targeting £60 million of savings in the current financial year, growing to a cumulative £140 million in the second year and reaching a recurring run-rate of £200 million per year by the end of the third financial year, which will end in 2021. Over half of the savings will be made in procurement and about a third from distribution operations, with about a tenth by consolidating central functions.

The supermarket expects the deal to make £2.5 billion in additional revenue ‘over the medium term’ with recurring incremental operating profit of at least £25 million annually by the end of its 2021 financial year. Tesco said it will be more focused on growing earnings and improving its free cash flow going forward in order to get shareholder returns back on track.

What other opportunities are there for Tesco?

Outside of Booker, Tesco is eyeing growth potential within its Mobile and Banking arms, as well as its core retail operation. The firm has identified a trend in fresh food after reporting a 0.7% rise in volumes in its last financial year (outperforming its three biggest peers), compared to a 7.2% drop in genetically-modified food volumes.

Tesco has also made substantial headway with its own-brand products, having been the first to introduce a ‘Value’ range in the 1990s. Own-brand sales now represent 51% of Tesco’s total sales in the UK and Ireland and Tesco Finest and Everyday Value are now the two largest food brands in the UK. It also has non-food brands under its belt like Technika and Chokablok.

What are Tesco’s financial targets for the 2019 financial year? 

  1. Deliver and underlying decrease in working capital of about £200 million per year
  2. Reduce its pension deficit by £285 million from April 2018, versus £270 million previously
  3. Spending was £1.1 billion last year and capital expenditure will be between £1.1 billion and £1.4 billion annually going forward
  4. To reduce total indebtedness so it is no more than three times annual earnings before interest, taxes, depreciation, amortisation and restructuring (EBITDAR), from 3.3 times now, with fixed charge cover greater than three times (from 2.7 times now)
  5. For its effective tax rate to fall from 25% to 20% over the medium term

Tesco share price: a technical analysis

Tesco has hit its highest level since April 2015 in the past month, breaking above the 220p level that marked the limit of its ambitions in 2016 and 2017. The next level to watch as it moves higher is 252p, last seen in April 2015. From here, the downtrend line from the September 2010 high would come into play around 270p. The steady uptrend from the 2015 lows would suggest even a retracement to 190p would find buyers.

Tesco’s financial calendar: when does the supermarket report next? 

Following the release of its latest annual results earlier this month, Tesco is due to update shareholders on its performance during the first quarter of its new financial year on 15 June, before releasing its interim results for the first half on 3 October.

It is also worth noting that Tesco shares will go ex-dividend on 17 May, when newly bought shares no longer qualify for the latest dividend payout, with the payment following on 22 June.

Learn more about share trading with IG.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

CFD’s zijn complexe instrumenten en brengen vanwege het hefboomeffect een hoog risico mee van snel oplopende verliezen. 79% van de retailbeleggers lijdt verlies op de handel in CFD’s met deze aanbieder.
Het is belangrijk dat u goed begrijpt hoe CFD's werken en dat u nagaat of u zich het hoge risico op verlies kunt permitteren.
CFD’s zijn complexe instrumenten en brengen vanwege het hefboomeffect een hoog risico mee van snel oplopende verliezen.