A trading statement from Tesco covering its third quarter and the Christmas period confirms a continuation of positive like-for like sales trends. However, disruption from the collapse of supplier Palmer & Harvey impacted sales over the period.
The shares fell 3.1% on the news.
The turnaround at Tesco is progressing.
This puts Tesco's ambition to improve margins to somewhere near 4% by 2019/20 under the spotlight. This may be lower than the 6ish% it was churning out up to 2013, but in our view meeting this guidance would still represent a good recovery. After all, the discounters have re-written the rules.
Stronger trading, particularly in the UK, has helped the dividend return earlier than many had expected. The payment may not be too significant as yet, with a prospective yield around 2.3%, but the plan is to build it to around half of earnings over time. An enticing prospect, but only significant if earnings can recover.
Progress has been good so far, particularly given recent improvements have been achieved despite sustained competition and a challenging UK market. With inflation outpacing wage growth, the spending power of the consumer has been falling in real terms.
The silver lining of the inflationary problem is that Tesco's sheer size enabled it to limit price rises to around 1% less than the wider market. This should boost its competitive position.
The other task facing the group is the acquisition and subsequent integration of Booker. Booker is the UK's largest cash and carry business, serving over 500,000 wholesale customers ranging from independent grocers to pubs and restaurants.
We expect the deal to complete at some point in this financial year, and much like Sainsbury's purchase of Argos, the deal takes the group in a new direction. Such a move comes with risks, but there should also be some easy wins; including synergies in distribution and corporate costs.
All in all, we think Tesco has coped with the challenges pretty well. While there are a few hurdles left to clear, the shares could be considered an attractive recovery play, although this type of investing does come with extra risk attached.
Third quarter and Christmas trading details
Like-for-like (LFL) sales in the UK grew 2.3% in Q3 (13 weeks to 25 November). This represents an eighth consecutive quarter of growth and continued market outperformance. Growth was recorded across all channels, with LFL sales growth of 1.8% in Extra hypermarkets, 2.3% in Express convenience stores and over 5% Online.
Tesco also reported LFL sales in the key Christmas period (six weeks to 6 January) were up 2%, although the group says this would have been 2.5% were it not for the lost tobacco sales following the collapse of wholesaler Palmer & Harvey. These challenges are said to be resolved.
Over Christmas, sales of fresh food brands and the Tesco finest range were particularly strong. While general merchandise sales dipped 0.6% on a LFL basis, clothing and cookery ranges performed well.
Taking the 19 week period as a whole, LFL sales in Central Europe, rose 0.6%, and fell 11.1% in Asia. The withdrawal of bulk selling activities in Thailand continues to be the main driver of the decline.
Tesco Bank sales grew by 4.8% over the 19-week period, with the number of savings and current accounts rising, and new mortgage customers added.
The group reiterated its confidence of hitting its full year and medium term targets.
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