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Tesco - Not a very Merry Christmas

Equity research team | 12 January 2017 | A A A
Tesco - Not a very Merry Christmas

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The 19 weeks ending 7 January saw group like-for-like (LFL) sales growth of 1.1%. The UK delivered a strong performance, with sales up 1.4%, although that slowed over the Christmas period.

Tesco believes it is on track to deliver underlying group operating profit of at least £1.2bn for the full year. The shares fell 2.2% following the announcement.

Our View

Momentum might have slowed a touch over the Christmas period, but overall Tesco's recovery is gaining traction.

While convenience and online tick over, its largest stores, which have been mercilessly targeted by Aldi and Lidl in recent years, have been turning in an improved performance. This reflects well on CEO Dave Lewis' strategy of focusing on in-store service levels and reinvesting in pricing.

In the long term, the group's move towards store ownership instead of leasing should mean free cash flow improves. While there has been no word from the group on the possibility of the dividend coming back, some analysts think a payout could return in the next year or so.

Tesco's stated target is to grow operating margins to 4% by 2019/20. While this may not be the heady 6% that the Tesco of old routinely achieved, it would be fanciful to expect to get back to that level after the disruption that the discounters brought to the industry.

A more positive tone to recent results shouldn't mask the fact that the group isn't out of the woods yet though. Despite the disposal of many non-core assets, the total debt hanging over the group is still significant. Low bond yields mean the pension deficit has ballooned, so more cash may be required to plug the shortfall after its next review in March.

Other wider headwinds include the challenge of coping with the higher import costs brought on by weak sterling. While Tesco says it is working hard to limit the impact on shoppers, the very public spat with Unilever about Marmite prices shows how difficult negotiations with suppliers can be.

Q3 and Christmas Trading Update:

Like-for-like UK sales growth of 1.8% saw Tesco gain market share in the third quarter, the first time it has done so since 2011 and the group's eighth consecutive quarter of like-for-like volume growth.

However, sales growth slowed over the six week Christmas period, with UK LFL sales up 0.7%. That was partly due to the decision not to repeat the Clubcard 'Boost' promotion, which reduced general merchandise sales by 0.8%. However, food-like-for-like sales rose 1.3%, with "significant market outperformance in fresh food". This includes increased sales in party food and Free From products, up 24% and 18% respectively, while clothing and toys also delivered strong performances, up 4.3% and 8.5%.

Operationally, Tesco saw on time deliveries to large stores improve to 98.9%, helping the group reduce stock levels by over £50m year-on-year, while improving availability over the peak Christmas period by 1%.

The 0.1% fall in international LFL sales came as the group lapped strong performance in both Asia and Europe last year. Market share grew in Thailand, despite weaker consumer spending, Hungary and Slovakia, offsetting the impact of intense competitive activity in Poland.

Tesco Bank saw sales grow 6.7% in the period, with total active customer accounts up 2.5%.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

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.

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