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Tesco squeezed by Asia slump

The supermarket chain has stuck to its long-term margin targets despite niggles in Asia and its banking division
October 3, 2018

A couple of misses in these half-year numbers from Tesco (TSCO) help to explain why the grocer's shares suffered such a negative reaction on results day. First, operating profits of £933m fell short of consensus estimates – and well short of broker Shore Capital’s £981m forecast. Most of that was down to trouble in Asia, where same-store sales contracted heavily in the opening quarter, margins were squeezed by 120 basis points and local profits landed at just £100m, down almost a third year on year. Add to this a slightly poor performance from Tesco Bank – which was recently fined £16.4m in relation to a November 2016 cyber-attack – and the closure of online general merchandise business Tesco Direct during the period, and these half-year results felt like a bit of a damp squib.  

IC TIP: Buy at 216p

That said, chief executive Dave Lewis is sticking to the now familiar margin narrative, which has helped support the stock’s investment case over the last couple of years. The aim is to grow operating margins to between 3.5 per cent and 4 per cent by FY2020, ensuring greater profitability for the group in the long run. Bulls believe this is an easier target now that the group has quality wholesaler Booker in tow, which helped to drive the 13 per cent improvement in half-year revenues. Others are more sceptical, wondering just where or how Tesco expects to boost margins as the grocery sector grows increasingly competitive.

But from our vantage point, there are steady signs of progress on this front already. Operating margins across the UK and Ireland have grown by 56 basis points year on year, which, combined with a 2.3 per cent improvement in like-for-like sales, helped operating profits soar by 47.6 per cent to £685m. Of course, Booker played a helping hand in the overall performance, but even excluding the wholesaler operating profits still grew by 26.7 per cent.

Shore Capital is preparing to review its forecasts, but prior to the results expected pre-tax profit of £1.9bn for the year ending February 2019, giving EPS of 14.9p (from £1.3bn and 11.9p in FY2018).

TESCO (TSCO)   
ORD PRICE:216.1pMARKET VALUE:£21.2bn
TOUCH:216-216.2p12-MONTH HIGH:267pLOW: 175p
DIVIDEND YIELD:1.7%PE RATIO:25
NET ASSET VALUE:147p*NET DEBT:22%
Half-year to 25 AugTurnover (£bn)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
201728.35537.71.00
201831.75644.41.67
% change+12+2-43+67
Ex-div:11 Oct   
Payment:23 Nov   
*Includes intangible assets of £6.46bn, or 66p a share