Tesco’s focus on value lifts sales but hits profits
Tesco is determined to keep prices low to maintain its sharpened focus on value as consumers struggle with the cost-of-living crisis. The UK’s largest supermarket chain said customers are ‘watching every penny to make ends meet’.
The intense focus on price is vital considering discounters Aldi and Lidl are the fastest-growing rivals, with the former recently becoming the fourth largest supermarket after overtaking Morrisons. Tesco said its pricing is now at ‘its most competitive position’ versus discounters ever, underpinned by its Aldi Price Match, Everyday Low Prices and its newly revamped Clubcard that is used by over 20 million households.
‘By staying laser-focused on value and sticking to our strategy of inflating a little bit less and a little bit later, our price position has got even more competitive. Customers are seeking out the quality and value of our own brand ranges as they work to make their money go further, whether they are switching from branded products, between categories or cutting back on eating out,’ said CEO Ken Murphy.
That appears to be attracting customers, with like-for-like sales in the UK and Ireland rising 2.7% compared to the 2.2% pencilled-in by analysts. Revenue rose 6.7% to £32.5 billion and beat the £32.0 billion forecast.
However, its determination to keep prices low is weighing on margins and contributed to the decline in profits. Adjusted retail operating profit – its headline measure – dropped 10% to £1.32 billion, although this was still better than the £1.23 billion estimate.
Tesco outlook remains uncertain
Tesco said it is now expecting to deliver adjusted retail operating profit of £2.4 billion to £2.5 billion over the full year. That has been narrowed from a previous range of £2.4 billion to £2.6 billion and Tesco warned that ‘significant uncertainties in the external environment still exist, most notably how consumer behaviour continues to evolve’ in response to rampant inflation and the amount it must spend on keeping prices low. That will mean annual profits will be down 12% to 15% from last year.
‘As we look to the second half, cost inflation remains significant, and it is too early to predict how customers will adapt to ongoing changes in the market,’ Murphy warned.
Shoppers have already started buying smaller baskets more frequently as they keep a closer eye on their spending, with management flagging that customers are also trading down to own-label products and shifting more to frozen from fresh. They have also pulled back on general merchandise and clothing as they tighten their spending on discretionary goods after splurging during the pandemic last year.
That suggests some risk still hangs over the outlook despite being tightened today. Retail sales in food stores dropped 0.3% in August, marking the first monthly drop in over a year, and the latest figures show consumer confidence in Britain sank to its lowest level since records began in the 1970s in September as people brace for a recession.
On a more positive note, Tesco upgraded its view on annual retail free cashflow and said this should come in at £1.8 billion this year. That has been tightened from the previous target range of £1.4 billion to £1.8 billlion, although this will still be down from the £2.3 billion in cashflow delivered last year.
Still, the more buoyant outlook for cashflow will help build confidence that shareholder returns will hold up even if the bottom-line remains under pressure going forward. Tesco raised its interim dividend by over 20% to 3.85p and still has £300 million left to spend under its share buyback programme, which should be completed ‘over the coming months’.
Tesco profitability to remain under pressure
With inflationary pressure taking its toll on profitability, tighter margins and rising costs are likely to remain a theme for the rest of the year and possibly into the next. Profits will undoubtedly decline this year, but it is important to flag that this will not only be down to the challenging environment but also tough comparatives from last year when supermarkets swallowed up sales during the pandemic (adjusted retail operating profit was up 55% last year).
Still, investors should welcome its strong appeal among consumers considering it continues to outperform its major rivals, managing to hold its market-leading position far better than the likes of Sainsbury’s that has ceded more market share to the discounters in recent years.
Where next for the Tesco share price?
Tesco shares are trading 0.7% higher in early trade this morning. The stock continues to rebound since hitting 199.9p last week, marking its lowest level since January 2019.
The stock is now testing the 211.6p level of support we saw in late 2019 and throughout 2020 which, if recaptured, will allow it to target 219.3p, in-line with the level of support seen in early 2021. From here, it can target the 211.2p level of support seen throughout 2019 and 2020 and then 222.8p to recapture the level of support seen throughout the second quarter of 2021. A break above here could open the door to a potentially larger jump toward 229.4p.
The 17 brokers that cover Tesco believe the selloff in recent weeks has been overdone with an average target price of 288.45p, implying there is over 40% potential upside. However, this has been curtailed from almost 308p in the past month alone.
The near four-year low should hold as a floor considering this plunged the RSI deep into oversold territory and attracted buyers back into the market, although any drop below here could see the stock drift to levels not seen since late 2018, toward 196.2p.
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