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Tesco's profits halve in tough grocery conditions

Higher costs and impairment charges dragged the retailer's bottom line down, but this was still a resilient performance
April 13, 2023
  • £750mn of buybacks over next 12 months
  • Dividend flat on previous year

The day before these results were released, Tesco (TSCO) announced that it would keep prices steady for over 1,000 everyday products until July and would cut milk prices for the first time since 2020. A sign of easing inflationary pressures, one might think. But chief executive Ken Murphy pointed to the “unprecedented levels of inflation in the prices we have paid our suppliers for their products, and the cost of running our own operations” as annual profits halved at the UK’s biggest supermarket due to higher costs and £982mn of non-cash impairment charges, mostly on property assets, as a result of higher interest rates.

Despite what is still a volatile cost environment, as demonstrated by recent Kantar data which showed that annual UK grocery prices rose by a record 17.5 per cent in March, management's outlook statement was, to quote Barclays analysts, "reassuring". The board expects retail cash adjusted operating profit, which strips out petrol, to be flat in 2024, a position which is just ahead of market consensus. And retail free cash flow is forecast to be in line with the target range of £1.4bn-£1.8bn - a £468mn working capital inflow helped this come in at £2.1bn for 2023, a solid result even if a 6 per cent contraction on the previous year. 

Higher prices drove the revenue uplift as lower volumes were hit by consumer spending pressures. UK and Republic of Ireland sales rose by 4.7 per cent, with Booker, the wholesale part of the business, enjoying its “strongest year ever” as sales jumped by 12 per cent to £8.7bn on the back of catering market share gains. Central Europe sales were up by 10 per cent, with management noting "strong growth" across both fresh and packaged products. 

In a cost of living crisis, the big supermarkets need a solid “value” offering as they battle it out with the discounters. And Tesco is delivering on this front. It has inflated prices behind the market and market share has been maintained through initiatives such as Aldi Price Match and Clubcard Prices. The company takes over 27 per cent of UK market share and is the only full-line grocer to have grown share against pre-pandemic levels. Rivals are belatedly taking action, with J Sainsbury (SBRY) recently unveiling a new Nectar card discount scheme. 

Shore Capital analysts said that Tesco “is now an effective cash compounder capable of delivering attractive total sequential shareholder returns centred upon modest underlying earnings growth, its retail free cash flow funded dividend, and the recurring buyback”. This thesis, which we believe to be accurate, is compelling. And the shares trade at a slight discount to the 5-year average valuation according to the consensus analyst position on FactSet, at 12.5 times forward earnings. Buy.

Last IC view: Buy, 245p, 12 Jan 2023

TESCO (TSCO)    
ORD PRICE:273pMARKET VALUE:£ 20.0bn
TOUCH:272-273p12-MONTH HIGH:289pLOW: 194p
DIVIDEND YIELD:4.0%PE RATIO:27
NET ASSET VALUE:167p*NET DEBT:£12.6bn
Year to 25 FebTurnover (£bn)Pre-tax profit (£bn)Earnings per share (p)Dividend per share (p)
201963.91.6213.15.77
202058.01.027.609.15
202157.90.645.609.15
202261.32.0319.910.9
202365.81.0010.210.9
% change+7-51-49-
Ex-div:11 May   
Payment:23 Jun   
*includes intangible assets of £5.38bn or 73p a share