Trading in the last six months has been better than expected, with group sales excluding fuel rising 3% to £27. 3bn, ignoring the effect of exchange rates. Tesco said the pandemic is still driving a higher volume of sales. Underlying operating profit rose 41% to £1.5bn.
Full year underlying retail operating profit guidance has been upgraded, and is now expected to come in between £2.5bn and £2.6bn. A £500m share buyback was also announced.
The shares rose 3.9% following the announcement.
Tesco is doing incredibly well. To have sales beat lockdown trading by 3% is really something.
The underlying picture is also positive. The group's retail sales are up over 8% compared to pre-COVID times. That's impressive in the uber competitive world of the big four supermarkets. Performance is being helped by Tesco's enormous scale. That means it's weathering the supply chain and distribution crisis well. The mature, deeply rooted nature of its relationships have been a key tool in allowing Tesco to keep its shelves well stocked, and outshining competitors in the process.
The other thing propping up sales is the impressive work that's been done on value-perception. Reducing prices on key items, but also ensuring quality, is helping Tesco outrun the German discount chains in particular.
Tesco's market leading position is what's helped it capture so much online demand over the last year, with 700,000 customers added and a huge boost in sales to match. Digital demand will remain heightened, a shift accelerated by the pandemic. The group's now fulfilling 1.3m orders in the UK each week.
There are some other things to keep in mind though.
Servicing the extra demand last year came with huge extra costs. An army of new staff and all that digital infrastructure took a hammer to profits. While recovery is stronger than expected, it's going to take time.
It hasn't helped that Tesco Bank sold its mortgage book to Lloyds last year, leaving it more exposed to credit cards and travel money. Reduced customer credit card spending is hurting the top line, although we're cautiously optimistic about the medium-term recovery.
Perhaps the biggest question mark is how competition is going to ramp up from here. The likely sale of Morrisons and an expansion drive at Aldi means the competitive landscape (read: pricing pressure) could get tougher in the short to medium-term.
Even if profit growth remains unexceptional at Tesco the dividend is of significant interest. A reinforced balance sheet currently helps underpin a 4.0% prospective yield, which is well covered by free cash flow. Remember no dividend is ever guaranteed, and yields are variable and not a reliable indicator of future income.
The £500m share buyback is a deviation from Tesco's traditional dividend plans. The decision to focus on one-off buybacks rather than recurring dividends could suggest management's aware it's in a once-in-a-generation sweet spot and unlikely to last forever.
We think Tesco is well placed, especially with a substantial growth opportunity of online shopping ahead of it. Annual free cashflows of over £1bn, a reliable revenue stream and market leading position are all serious benefits, not necessarily reflected in the price to earnings ratio of 12.7. Remember though, ups and downs are possible, depending on how competition shapes up from here.
Tesco key facts
- Price/Earnings ratio: 12.7
- 10 year average Price/Earnings ratio: 11.5
- Prospective dividend yield (next 12 months): 4.0%
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.
Half Year Results
The half year performance was largely driven by the UK & Republic of Ireland (ROI), where like-for-like sales (LFLs) rose 2.4% to £25.0bn. Sales were better than expected in the UK, helped by staycation trends and the Euros, while wholesaler business Booker saw a sharp recovery in its catering revenue. Underlying operating profit rose 16.5% to £1.3bn.
Online LFLs are up 74.1% on pre-pandemic levels, and 2.3% ahead of last year. The group has added around 700,000 customers since the start of the pandemic, and online sales now make up 14.6% of total UK sales.
LFL sales in Central Europe rose 1.4%, to £1.9bn, with a mixed picture in different markets depending on restriction levels. All markets returned to growth in the second quarter. Underlying operating profit improved 18.6% to £68.0m.
In the Bank business, underlying operating profits more than doubled to £72m. Ignoring the impact of acquisitions, revenue fell 12.2% as customers cut credit card balances following lower spending. The net interest margin rose to 5.1% from 4.6%.
Tesco incurred costs of £193m relating to settlements from the 2014 accounting scandal.
Retail free cash flow rose to £1.5bn from £0.8bn, helped by the non-recurrence of pension contributions associated with the Asian business. Net debt, including lease obligations fell to £10.2bn from £12.0bn.
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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