- Free cash flow from retail arm nearly doubles to £1.5bn
- Stronger UK sales and bank turnaround help to grow profit
Tesco (TSCO) shares climbed 6.5 per cent on results day after it announced it would complete £500m worth of buybacks over the next 12 months. The UK’s biggest supermarket chain said it had reassessed its capital structure and would use a simple target for leverage of 2.3-2.8-times net debt to cash profits, stripping out the inclusion of its £455m pension deficit due to its volatility, and the fact it has “no bearing on our near-term cash obligations”. The group also plans a progressive dividend, targeting a pay-out of 50 per cent of earnings, and will weigh up “inorganic growth opportunities as they arise”.
Tesco reported a 3 per cent increase in sales, excluding fuel, for the half year and said it had grown market share, with adjusted operating profit climbing 41per cent to £1.46bn – exceptional items included £193m in legal costs to settle claims dating back to its overstatement of expected profits in 2014.
Its profit growth was attributed to stronger UK sales, a reduction in costs relating to Covid-19 and the fact that Tesco Bank reversed an operating loss of £155m in the first six months of last year to a profit of £72m this time.
Tesco’s total debt, including its pensions liability, was cut to £10.7bn (or 2.8 times cash profits) from £13bn (3.6 times) at the end of February, as the pension deficit halved and it used stronger retail cashflows to reduce borrowings. Retail free cash flow almost doubled to £1.54bn and the group said it will target free cash flow generation of £1.4bn-£1.8bn per year from now on.
The retailer had a 27.3 per cent share of the UK grocery market in the 12 weeks to 5 September, a 50 basis-point improvement on the same period last year, according to Kantar Worldpanel. J Sainsbury (SBRY) also made a slight gain of 10-basis points, but Asda and Wm Morrison Supermarkets (MRW) – both of which have recently been subject to private equity-backed takeovers – gave upmarket share.
Tesco's scale means it is “weathering the supply chain crisis better than others”, said Sophie Lund-Yates, senior equity analyst at Hargreaves Lansdown. “It’s times like these when being the biggest fish in the pond really counts.”
The cash Tesco is looking to generate could spur further buybacks or special dividends, barring any significant mergers and acquisitions, analysts from Shore Capital said in a note. Tesco is trading below FactSet consensus valuation estimates and given that two of its main competitors are likely to find themselves more heavily indebted following private equity buy-outs, it is in a position to use its scale and cash resources to extend its market lead. The shares have near-term momentum, and offer an attractive forward dividend yield of 3.6 per cent. But trading at a five-year high, they offer limited share price upside. Hold.
Last IC View: Hold, 222p, 14 Apr 2021
|ORD PRICE:||267p||MARKET VALUE:||£ 20.6bn|
|TOUCH:||266-267p||12-MONTH HIGH:||270p||LOW: 202p|
|DIVIDEND YIELD:||3.4%||PE RATIO:||21|
|NET ASSET VALUE:||173p||NET DEBT:||100%|
|Half-year to 28 Aug||Turnover (£bn)||Pre-tax profit (£bn)||Earnings per share (p)||Dividend per share (p)|
|* Includes intangible assets of £5.4bn, or 70p per share|