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Tesco - turnaround complete, CEO steps down

Nicholas Hyett | 2 October 2019 | A A A
Tesco - turnaround complete, CEO steps down

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Tesco plc Ordinary 5p

Sell: 211.80 | Buy: 212.00 | Change -2.60 (-1.21%)
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Group sales excluding fuel, fell 0.4% to £28.3bn. However, improved margins in the UK business meant underlying operating profit increased 24.4%, to £1.4bn.

CEO Dave Lewis will be stepping down in summer 2020, to be replaced by Ken Murphy - Chief Commercial Officer and President Global Brands at Walgreens Boots Alliance.

An interim dividend of 2.65p has been announced, up 58.7% on last year.

The shares were broadly unmoved by the two announcements.

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Our view

Margins have hit targets, and the brand has been refreshed. Savvy deals with Booker and Carrefour have created significant cost saving opportunities, and in a ferociously competitive marketplace, that's helped operating profit grow. With much of the heavy lifting complete it is perhaps a natural time for Dave Lewis to hand the reins to someone else.

But that's not to say incoming CEO, Ken Murphy, doesn't have work to do. Aldi and Lidl remain a threat and Walmart is willing to offload Asda. A sale, whether to private equity or an existing rival, could mean the brand gets new life breathed into it - increasing the chance of another price war. That's got the potential to undo some of the good work on margins.

Other initiatives haven't been quite as successful. We're yet to get a meaningful update from Jack's - Tesco's discount store chain. Fortunately store numbers are limited at the moment, so if the project runs aground the cost will be minimal. Tesco Bank has also had a shakeup. The move out of mortgages significantly reduces the division's scale, and should free up capital too.

There is a question about what the extra cash from sale of the mortgage book will be used for, especially as the company's balance sheet has continued to improve. Debt continues to fall, meaning leverage is at more comfortable levels. Added to that, Tesco now owns the majority of its stores, which means there are fewer onerous leases to deal with.

All things considered Murphy will be taking on a far healthier beast than Lewis inherited. A dominant market position and healthy margins should equip it well to face growing competition. The challenge will be finding a way to deliver growth in the years ahead.

The shares offer a prospective yield of 3.6%, and trade on a price to earnings ratio of 13.7 - slightly below the longer term average of 14.1.

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Half year results

Sales in the UK & Ireland rose 0.2%, to £22.4bn. On a like-for-like basis (LFL) there was a 0.1% increase. That reflects the tough comparison with last year, when warm weather and the Royal Wedding boosted performance. Booker sales improved 2.3%, and are on track to deliver cumulative cost savings of around £140m by the end of this year.

Underlying margins in the UK & Ireland rose 0.9 percentage points to 4.2%, driving adjusted operating profits up 28.4% to £1.1bn.

Central Europe saw sales slide 6.3% to £2.8bn, ignoring the impact of exchange rates. LFL sales fell 3.1%. That comes as Tesco re-shapes the Polish business, including closing stores and tightening the range on offer. Coupled with lower margins, adjusted operating profit was £63m, a decrease of 14.7%.

Asia adjusted operating profit of £171m was 42.3% higher than last year. That reflects sales growth of 1%, ignoring exchange rates, and accelerated cost savings in Thailand.

Higher profits saw retail free cash flow rise to £814m (2018: £397m), while net debt of £12.6bn is 7.8% lower than this time last year.

Tesco Bank profits dipped 3.3% to £87m, as a result of the group cutting prices of insurance products to improve competitiveness and increases in bad debts. In September the group confirmed the sale of its £3.7bn (approx.) mortgage portfolio to Lloyds Banking Group.

Find out more about Tesco shares including how to invest

Hargreaves Lansdown's Non-Executive Chair is also a Non-Executive Director of Tesco.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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 disclosure for more information.