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Tesco - profits and dividend rise, but unable to give guidance

Sophie Lund-Yates | 8 April 2020 | A A A
Tesco - profits and dividend rise, but unable to give guidance

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Tesco plc Ordinary 5p

Sell: 228.30 | Buy: 228.50 | Change -5.80 (-2.48%)
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Full year group sales declined 1% to £56.5bn, ignoring the impact of exchange rates. That includes subdued market growth in Tesco's biggest market, the UK & Ireland. Group underlying operating profit rose 12.6% to £3bn, as operating margins rose to 4.6% from 4.1%.

Sales volumes are now stabilising following the uplift from panic-buying behaviour, but demand continues to outweigh supply of online deliveries. There are "significant extra costs" associated with the increased demand for groceries at the moment, including paying around an extra 45,000 members of staff. The estimated overall impact will be a £650m -£925m increase in retail costs.

The level of uncertainty means Tesco is unable to give guidance for next year. If trading returns to normal by August it believes the extra costs will be offset by the increased sales, as well as the business rate relief announced by the government.

The group announced a final dividend of 6.5p per share, taking the full year payment to 9.15p.

The shares fell 3.7% following the announcement.

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Our view

Food retailers are essential, which holds Tesco in good stead during a pandemic.

The initial sales uplift as people panic-purchased was so significant the group thinks it will be able to offset the burden of higher operating costs as far out as August. Sales volumes have normalised, which is to be expected, but one thing's for certain - we're going to keep needing the supermarkets no matter how long lockdowns go on for. That gives the group good visibility over its revenue streams.

Of course, continued success is hinged on supply chains coping with the pressure. These have squeaked, but overall seem to be in good shape.

But even before coronavirus Tesco was making good progress.

Margins hit targets and the brand was refreshed. Savvy deals with Booker and Carrefour 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 incoming CEO, Ken Murphy, still has work to do. Aldi and Lidl remain a threat and it's increasingly apparent that Walmart is looking to offload Asda. A sale could breathe new life into the brand - potentially sparking another price war and undoing some of the good work on margins.

The proposed sale of the Asian business will provide a serious cash injection for the group. If it goes ahead shareholders can expect a special dividend, which is in stark contrast to the swathes of businesses shelving dividends in the wake of the current disruption. Investors should remember though, no dividend is ever guaranteed and that's particularly true at the moment.

The group may decide to keep the extra cash on the balance sheet in case COVID-19 throws up unexpected road blocks. At the moment the group seems to be managing the disruption well, but costs will be the main thing to watch from here. If conditions last for longer than expected, profitability could come under strain.

To the group's credit the balance sheet is in decent health. But even the strongest balance sheets could feel the pressure in the event of an unexpectedly bad spell.

All things considered Tesco's dominant market position and healthy margins should equip it well to face these challenging times. But the next few months will be important, and the level of uncertainty means we can't rule out further ups and downs from here.

The shares offer a prospective yield of 4.9% and trade on a price to earnings ratio of 12.1.

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Full year results

COVID-19 update

145,000 extra home delivery slots have been added in the last two weeks increasing capacity by 20%. The group is working to prioritise vulnerable customers.

All cafes, phone shops, meat, fish, deli counters and salad bars are closed. Tesco is also working with its suppliers to simplify its range of products and to improve availability of the most popular products.

Colleagues ill with COVID-19 or in isolation are receiving full pay from the first day of absence. Colleagues who are over 70, vulnerable or pregnant are receiving fully paid 12-week absences.

Tesco Bank is expected to have lower income, including credit cards, loans and travel money. Combined with a higher provision for bad debts, the bank is expected to generate a loss next year.

Full year results (constant currency)

Underlying sales in the UK & Ireland underlying sales rose 0.2% to £45bn, as like-for-like (LFL) sales also rose 0.2%. That reflects a good response from customer incentives, as well as above-market sales of fresh food. Booker saw LFLs increase 3.3%, while overall sales rose 5% to £6.1bn.

The group achieved cumulative Booker synergies £207m - delivered a year ahead of target. Tesco also acquired Best Food Logistics in early March.

Underlying operating profit rose 16.9% to £2.2bn, as margins improved 0.51 percentage points to 4.21%. The increased profitability reflects a more favourable mix of products, cost control and efforts to simplify stock control.

Across Europe, the group continues to restructure its operations - particularly in Poland and this impacted the region's results. Underlying sales fell 10.1% to £5.3bn, with overall LFLs sales falling 6.4%. Underlying operating margins dipped to 2.8% and underlying operating profit fell 27.6% to £156m.

Asia profits rose 24.8% to £426m. Next year, Asia will be treated as a discontinued operation following the announcement on 9 March 2020 of the proposed sale of the businesses in Thailand and Malaysia.

The proposed sale is expected to generate cash proceeds of around £8.2bn and is contingent on shareholder and regulatory approval. Tesco intends to use the proceeds by returning £5bn to shareholders via a special dividend and eliminate the pension deficit with a £2.5bn one off contribution.

Tesco Bank profit declined 3% to £193m. The group acknowledged a £56m non-cash charge following the decision to close its current account business. It also recognised an extra £45m provision to compensate an unexpectedly high number of claims relating to PPI last year.

Retail free cash flow increased £1.2bn to £2.1bn, as a result of better profitability, decreases in working capital and the sale of Tesco's share in Gain Land. Adjusted net debt fell 8.4% to £12.1bn.

The group intends to maintain a full-year dividend pay-out ratio of 50% going forward. From 2020/21 the interim dividend will be set at 35% of the prior year full-year dividend.

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The Chair of Hargreaves Lansdown is also a Senior Independent Director of Tesco plc.

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.

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