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Tesco - agrees sale of Polish business

Sophie Lund-Yates, Equity Analyst | 18 June 2020 | A A A
Tesco - agrees sale of Polish business

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Tesco has agreed the sale of its Polish business for total net proceeds of around £165m. In the last financial year these stores generated a loss before tax of £107m. The sale is expected to complete in the current financial year.

CEO Dave Lewis said: "we have seen significant progress in our business in Central Europe, but continue to see market challenges in Poland." The group will now focus its central European efforts on the remaining businesses in the Czech Republic, Hungary and Slovakia.

Outside of this transaction Tesco has been selling its remaining Polish property, with sales completed or agreed on 22 stores worth £200m in the last 18 months.

The shares were unmoved 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 can offset the burden of higher operating costs as far out as August. Sales volumes are now starting to normalise as expected, and it will be a little while until we know for sure what the lumpier trading patterns mean for the full year. That means it's important to look at the underlying progress made before coronavirus.

It's hard to knock the group's performance - 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.

The main challenge for new CEO Ken Murphy will be finding ways to propel more sales and profit growth from here. There's also the fact 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 sale of the Polish business therefore strikes us as sensible. Grasping the nettle and disposing of a profit-diluting division is the right thing to do and should make Tesco's foundations stronger. The cash will further boost the balance sheet too, which is prudent in case COVID-19 throws up unexpected road blocks. If conditions take longer than expected to recover, even the most robust balance sheets will come under pressure.

The proposed sale of the Asian business will provide another serious cash injection for the group, and the proceeds are earmarked for a special dividend. Remember though, no dividend is guaranteed and that's particularly true at the moment.

All things considered Tesco's dominant market position and healthy margins should equip it well to face these challenging times. And looking longer-term we think the group has enough in its armoury to deliver another round of growth - we're just going to have to wait and see exactly how the new man at the top intends to make that happen.

The shares offer a prospective yield of 3.8% and trade on a price to earnings ratio of 14.6.

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Full year results (8 April 2020)

COVID-19 update

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.

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)

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%.

Current 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.

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.

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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