Tesco guides for operating profit fall

The market gave the thumbs-down to Tesco’s (TSCO) full-year figures for FY 2022. The initial markdown of the shares seems curious given a 35.8 per cent increase in adjusted operating profit for its core retail segment, alongside a 69.9 per cent increase in related cashflow. Investors are probably giving more weight to the outlook for the net margin over the near- to medium-term. Management is guiding for annual operating profits of £2.4-2.6bn, a potential shortfall of up to £400mn from this time around, with a wider spread than usual down to uncertainties over the severity and duration of the inflationary spell.  

It’s too early to assess the impact that inflation (at a multi-decade high) will have on consumer behaviour, though it’s not difficult to make an educated guess. We have already seen upmarket rival Marks and Spencer (MKS) cut prices on a range of household staples, a clear sign that the supermarket price war is in the offing. The German discounters would seem to be handily placed as the cost-of-living crisis unfolds, but the UK’s largest grocer is already extending price-saving initiatives such as Aldi Price Match, and is looking to drive cost savings over the next three years to bolster margins against an inflationary backdrop.

Tesco’s service offering is certainly a plus point, a potential differentiator between it and its price-point conscious rivals. The group confirmed that online sales remain well ahead of pre-pandemic levels, with its share of the UK market up 142-basis points to 34.8 per cent. It has also continued to roll-out its click-and-collect and superfast delivery services. Anecdotal evidence suggests that online grocery shopping is gaining custom partly because it allows shoppers to take advantage of discount codes and comparison websites.

Tesco’s overall UK market share increased 30-basis points to 27.7 per cent, the highest jump since 2007, but it is still well adrift of the rate a decade ago. It would be loath to lose any more ground to the discounters, hence the intensified focus on price. Strengthening cashflows enabled the group to reduce net debt by £1.4bn, leaving the debt/cash profit multiple at 2.5. Management assumes that the group will “incur a significantly lower level of Covid-19 costs as colleague absence rates return to pre-pandemic levels”. It has also committed to buying back a total of £750mn worth of shares over the next 12 months. The net margin (1.7 per cent five-year average) will undoubtedly come under pressure, but we think the stock will still find support at 12 times consensus forecasts, particularly given a forward yield of 4.3 per cent. Buy.  

Last IC view: Buy, 287p, 13 Jan 2022