Group sales rose 7.0% to £19.9bn in the 19 weeks to 11 January 2021. That reflects strong trading across the third quarter, and a record Christmas. That was entirely driven by the UK & Ireland, with Central Europe and Tesco Bank recording declines.
The "increasing severity" of the pandemic means Tesco has upped its predicted Covid-related costs for the full year by £85m, to £810m. However, this is expected to be offset by increased sales. Full year guidance is unchanged - underlying retail operating profit is expected to be "at least" at the same level as last year.
The shares fell 1.4% in early trading.
The core retail business is seeing sales spike.
Smaller Christmas gatherings didn't stop people treating themselves. And accelerated shopping trends are set to carry on as we continue to spend more time at home. Lots of the demand is digital, with online sales increasing as the year progressed - growing from 9% of total UK sales to 16% by the end of the first half.
Online demand will hang around, and the group plans to open more than 25 Urban Fulfilment Centres over the next 3 years to improve delivery efficiency. There is big competition online, but we think Tesco's huge national footprint puts it in a good position to snatch a large piece of the online-grocery pie.
Of course, these things don't happen for free. Shifting online has required investment and, together with new social distancing rules, has seen the Tesco hire 16,000 permanent staff. The benefits of increased scale are propping up margins and offsetting increased COVID-related costs. But keep in mind, including the repayment of the government's business rate relief, profits are likely to be stable this year -not stratospheric.
The pandemic is having knock on effects outside the retail business too.
Tesco Bank sold its mortgage book to Lloyds last year, so interest income was always going to decline substantially. However, reduced economic activity related to the pandemic, financial relief for struggling customers and more money put aside for bad loans, means the bank is likely to be loss making this year.
With the core UK business undergoing some major restructuring the group has sped up its exit from international markets. The sale of the Thai and Malaysian business is most notable - bringing in £8.2bn of cash. Around £5bn will come back to shareholders, through a special dividend and share consolidation, and £2.5bn has already gone on the pension deficit. This gives the group increased freedom to invest in the core UK business and leaves the balance sheet in a reasonable position.
Increased UK focus may well prove invaluable, as new CEO Ken Murphy has his work cut out. A reinvigorated Asda shouldn't be dismissed following its recent sale by Walmart. Another price war risks undoing the good work done on margins and Tesco's 26.8% market share and mid-market position means it's a target for both premium and value rivals.
Groceries are a defensive sector: no matter what happens, we need to eat. But on top of that, we're fans of Tesco's strategic direction and think online shopping offers real potential. These factors should give it an edge over some rivals. The prospective yield is supported by what should be reliable revenue too. Remember no dividend is ever guaranteed. The question from here is how severely, and quickly, competitive pressure mounts. A fast change in the status quo would disrupt progress.
Tesco key facts
- Price/Earnings ratio: 14.2
- 10 year average Price/Earnings ratio: 14.3
- Prospective yield: 3.8%
All ratios are sourced from Refinitiv. 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.
19-week third quarter and Christmas trading details
UK & Republic of Ireland (91.3% of group sales) sales rose 8.5% in the third quarter, and 8.4% over Christmas. Within that, the UK saw a 7.2% increase overall, to £14.7bn. That was driven by a record Christmas, and sales growth across all channels and categories. Online saw an 80% rise in sales, equivalent to almost £1bn of extra sales across the period as a whole. The strong Christmas performance was boosted by increased demand for Tesco Finest products. Since launching the Aldi Price Match initiative, customer value perception has jumped 450 basis points. ROI sales rose 12% to £1bn.
Booker recorded a 12.4% increase to £2.5bn. Excluding the acquisition of Best Food Logistics, sales fell 2.5% on a like-for-like basis. The weakness reflects Covid disruption in the hospitality sector.
A decline of 1% was seen in Central Europe, which recorded sales of £1.5bn. Sales ticked up in the third quarter, but were weak over Christmas. Tighter lockdown restrictions affected trading in these markets.
Tesco Bank continues to face headwinds from the pandemic, including adverse banking activity and reduced travel money demand. Sales dropped 27.7% to £261m, and Tesco Bank still expects to report a loss of £175m - £200m for the full year.
The £8.2bn sale of the businesses in Thailand and Malaysia completed on 18 December 2020. A one-off £2.5bn contribution has been paid to the group pension scheme. Around £5bn will be returned to shareholders, via a special dividend followed by a share consolidation, subject to shareholder approval.
HL's Non-Executive Chair is also a Non-Executive Director at Tesco.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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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