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Tesco - reports strong first quarter sales

Sophie Lund-Yates, Equity Analyst | 26 June 2020 | A A A
Tesco - reports strong first quarter sales

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Tesco's total sales rose 8% to £13.4bn in the first quarter, excluding fuel and the effect of exchange rates. That reflects like-for-like (LFL) growth of 7.9%, with sales improving in all geographies.

The increase in sales is being offset by increased costs, which are largely associated with payroll, including 47,000 extra members of staff.

Although uncertainty still remains, the group thinks full year underlying Retail operating profit will be flat compared to last year. Increased provisions for bad debt means Tesco Bank is expected to report a loss of £175m - £200m.

The shares fell 1.3% following the announcement.

View the latest Tesco share price and how to deal

Our view

Coronavirus saw sales increase at Tesco, but the rewards are being offset by swelling associated costs. Wages for an army of temporary staff is the price one must pay to keep a panicked nation fed.

That means the full year picture looks a little gloomier than we'd been expecting just a few short months ago. But compared to a lot of non-essential shops, flat retail profit is nothing to complain about in the current climate. And in reality, it's important to look at the underlying picture before the pandemic disruption.

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 that despite some good progress, Aldi and Lidl remain a threat. It's also 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.

Over the longer-term online sales will also provide a meaningful boost. Coronavirus has accelerated demand for grocery deliveries, and Tesco has massively stepped up its capacity. For now the bulk of sales are still driven by a shop visit - but this is a good growth lever to have.

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.

Tesco key facts

  • Current 12 month forward price to earnings ratio - 14.5
  • Ten year average price to earnings ratio - 14.2
  • Prospective yield - 3.8%

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Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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First quarter trading update

Overall sales in the UK & Ireland rose 9.2% at constant currency to £12.2bn. That includes LFL growth of 8.2%. Booker reported a 6.1% rise in sales to £1.6bn, helped by a strong increase in sales at convenience store partners, which was partially offset by a 32.1% decline in catering-related business. Online sales were up 48.5% for the quarter, but increased capacity meant this had increased to almost 100% by the end of May. Digital sales now account for over 16% of UK sales, compared to 9% before lockdown.

Within the UK, food sales rose around 12%, but items which rely on more discretionary spending, like clothing, fell about 20%. General Merchandise sales are starting to recover.

Tesco has seen a higher number of customers switching to Tesco from Aldi. Customers are also opting for fewer, but higher-value trips to supermarkets.

In Central Europe (excluding Poland) LFLs rose 3.9%, which fed into an overall sales increase of 3.3% to £968m. Customers are continuing to prefer more essential items, and online sales more than doubled in the quarter.

The sale of the Polish, Thailand and Malaysian businesses are expected to complete in the current financial year, with the latter two due in the second half.

In Tesco Bank, the group has further lowered its expectations for the economy meaning it's increased its provisions for bad debt, which will see the division report a full year loss. Sales in the quarter were down 26.5%, with travel money and products being particularly affected. The CET1 ratio (a key measure of banking capitalisation) stands at 21.8%.

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

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