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Tesco - full year expectations upgraded

Tesco's group sales rose 8.4% to ?30.7bn, ignoring the effect of exchange rates.

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Tesco's group sales rose 8.4% to £30.7bn, ignoring the effect of exchange rates. This included Retail like-for-like (LFL) growth of 7.8%. The group's biggest market, the UK, saw LFL growth of 8.7%, with sales of £21.8bn. Tesco has continued to invest in keeping prices low, with inflation falling in the period. Tesco Finest ranges have seen positive momentum, with UK volumes of the range rising 4.1%. Overall trading has been better than expected.

Underlying retail operating profit rose 13.5% to £1.4bn. The better-than-expected performance means Tesco has slightly upgraded full year expectations, with underlying retail profit now expected to be £2.6 - £2.7bn.

There was a 6.6% increase in retail free cash flow to £1.4bn and net debt fell to £9.9bn from £10.0bn.

An interim dividend of 3.85p was announced, in-line with last year.

The shares rose 2.7% following the announcement.

View the latest Tesco share price and how to deal

Our view

The grocers are a resilient bunch. They sell the non-negotiables that people can't do without, regardless of how the economy's affecting household incomes. And we think Tesco has a best-in-class offering.

Its enormous scale and the mature, deeply rooted, nature of its relationships has been a key tool in allowing Tesco to keep its prices down. The group's strategy relies on being able to offer better all-round pricing than the competition, and Tesco's delivered remarkably well on that. That's helped keep sales moving in the right direction. And with inflation falling, it's a trend we'd hope to see continue.

The group's expanded its Tesco Finest range, helping it poach customers from more premium supermarkets. And those who already shop at Tesco are treating themselves at home rather than going out, boosting Finest volumes. We view both of these shifts as potentially long-term in nature, meaning there's more juice to be squeezed.

And Tesco isn't just a retailer, although that's the bulk of the story. The wholesaler, Booker, is performing well, partly helped by a recovery in catering. There's also Tesco Bank, which is seeing an income boost thanks to higher interest rates, and we have no qualms about the bank's balance sheet.

But for all the positives, there are things to keep in mind. The small upgrade to retail profit expectations is welcome, but growth isn't shooting the lights out. Aldi and Lidl may not be an existential threat, but they are nabbing shoppers from bigger names. The real test will be Christmas, where consumers will want to put on as much of a feast as possible, but where wallets may not allow it. We could face a race to the bottom on festive pricing, which would spell trouble for margins.

We're also keeping an eye on Clothing & Home sales. These aren't the main story, but they do count. Growth here has slipped, which reflects the decision to exit lower margin categories, including big electrical items and footwear. This makes sense in the current environment while people resist spending on non-essentials. But even without these cuts, growth in the category was flat. To that end, it's something we'll be keeping an eye on.

Tesco's balance sheet and free cash flow are in good health, which helps underpin an attractive dividend yield. No dividend is ever guaranteed.

Tesco's more reliable revenue streams, market-leading proposition and income potential have given the group's valuation a boost so far this year. But we don't see the valuation as overdone. Short-term sentiment will be driven by how Christmas competition shapes up in the sector and how margins are looking on the other side.

Tesco key facts

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.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. 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.

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 disclosure for more information.

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Written by
Sophie Lund-Yates
Sophie Lund-Yates
Lead Equity Analyst

Sophie is a lead on our Equity Research team, providing research and regular articles on a selection of individual companies and wider sectors. Sophie's specialities are Retail, Fast Moving Consumer Goods (FMCG), Aerospace & Defence as well as a few of the big tech names including Facebook and Apple.

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Article history
Published: 4th October 2023