US Edition Tesco
294p-3.5
Questor says SELL
The first quarter trading update from Tesco [LON:TSCO] yesterday highlights the widening gulf between the UK’s largest grocer and the reality on the shop floor. Questor thinks this is a real cause of concern for investors who are backing Tesco to turn things around in a rapidly changing retail market.
Investors need read no further than the first line of yesterday’s trading update to know what is wrong at Tesco. “Our accelerated plans are making a real difference for customers and we are more competitive than we have been for many years,” said Philip Clarke, chief executive.
UK shoppers and all the data is telling us otherwise. Britain’s largest grocer reported UK like-for-like sales down 4pc excluding fuel, worse than the 3.5pc fall expected by analysts at Shore Capital. Total UK sales were down 1.7pc excluding petrol and 2pc including petrol.
Mr Clarke said the company had cut prices on “the products that matter most” and cut home delivery charges. He detailed £200m of price cuts at the time full year results. Alongside the annual results Philip Clarke, chief executive, said the grocer is responding to the challenging trading by focusing on providing the “most compelling offer for customers”.
Questor thinks it is strange that UK households scouring the shops for offers have missed the difference that Tesco is making. Mr Clarke cited “challenging consumer trends” in the UK, so challenging that discounters Aldi and Lidl continued to deliver double digit sales growth during the comparable period.
The price cuts just don’t look enough as others are clearly offering better value. Tesco can still afford to make big price cuts as it is still profitable and highly cash generative. The company retained one of the highest retail profit margins of the UK supermarkets of 5.03pc at the time of the annual results to February, well ahead of rival Sainsbury’s at 3.47pc. The market expects the margin to come down to 4.5pc in the next year, but this doesn’t look enough in the current environment.
The store refurbishment programme looks too slow. The company said it had refreshed 100 stores during the first quarter, and plans to spruce up another 200 by the end of August. Refreshing 300 stores within six months would still be less than 10pc of Tesco’s total estate of 3,378 stores across the UK. At this rate the company will have completed the store refreshment some time in 2019.
Tesco said it was accelerating its plans, but it increasingly looks as if they are still stuck in reverse. Declining real incomes are nothing new and have been a trend since 2008, and other retailers have fared much better than Tesco. Questor thinks the company has been asleep at the wheel.
The company still has some room for manoeuvre. It has a dominant share of 29pc of the UK market. Tesco also said it will reduce investment in overseas operations and cut total investment spend from £2.7bn last year to not more than £2.5bn in the year ahead. That company made £3.2bn in cash from operation in the year ended February and reducing investment further would free up cash for slashing prices.
Questor has been nothing if not consistent with its views on Tesco. When we first recommended selling the shares at 358p, on October 2 last year, it was classed as a contrarian view. When we repeated the warning on December 5 the shares had slipped to 340p, and we echoed those views in March with the shares down to 303.7p. As Questor repeated in early April (Sell, 293.8p) there has been no fundamental change in strategy since last October. On that basis the recommendation remains unchanged. Sell.