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Tesco: 'Continued Positive Momentum'

George Salmon | 23 June 2016 | A A A
Tesco: 'Continued Positive Momentum'

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Tesco have this morning released a first quarter trading update, which confirmed a second successive quarter of like-for-like sales growth in the UK. The shares rose by over 2% this morning.

Q1 Highlights:

  • In the UK, LFL sales increased 0.3%, slightly ahead of analyst expectations. Volumes increased 2.2%, and transactions by 1.7%
  • Total sales grew 1.1% at constant exchange rates, assisted by International LFL sales increasing 3.0%. International volumes increased 2.7%, with transactions up 1.5%.

Tesco have reduced spending on multi-buy and promotional coupons, instead investing in lower, more stable prices. Tesco launched seven fresh food brands in March, and say these brands have been well received by customers. The lower prices of these ranges have contributed towards an overall deflationary impact of c. 0.7% on UK LFL sales. The cost of a weekly shop at Tesco is now 6% lower than it was in September 2014.

Tesco continue to work on improving the customer experience and improving operating efficiency. Stock availability and customer satisfaction are both reported to have increased, as recognised by Tesco being voted as 'Britain's Favourite Supermarket' at the Grocer Gold Awards last week.

Following the previous announcement of the sales of Giraffe, Dobbies and the group's Turkish business Kipa, Tesco are today announcing the proposed sale of Harris + Hoole to Caffe Nero.

Tesco CEO Dave Lewis said that he is "confident that the improvements Tesco are making for customers are working and will create long-term value for shareholders."

Our View

With the supermarket price wars seemingly no closer to ending, Tesco has battened down the hatches and is firmly in 'recovery mode'. The group continues to lower prices, and invest in better availability and range of stock.

Chief executive Dave Lewis has ordered all hands to the pump, which has meant the reinvestment of profits back into the pricing proposition rather than paying a dividend to shareholders. Tesco has also slimmed down to focus on its core UK market, and disposing of non-core assets has reduced Tesco's debt burden. With fewer stores opening, capex has been scaled back, meaning that free cash flows are set to improve from here.

We think that Mr Lewis is right to focus on the customer, given where Tesco had got to. So far the strategy seems to be gaining traction. Food prices are still falling, but customers are responding to Mr Lewis's changes and transaction numbers and grocery volumes are now moving ahead. As a result, recent quarters have seen like for like sales return to positive territory. Investors will hope that this marks a turning point for Tesco.

However, as with any recovery story, there are doubts. The entrance of Aldi and Lidl, and the ensuing price wars, has permanently altered the landscape of the industry, so it seems unlikely that profits or margins will return to historic levels any time soon. The longer Tesco are obliged to 'reinvest in pricing', the less visibility investors will have on the group's future profitability.

In addition, shares across the sector have been weak recently, not least due to the news of Amazon's London-focused online grocery service launching.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.