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Tesco - profits fall as inflation dents volumes

Tesco's sales rose 5.3% to £57.7bn last year, ignoring the effect of exchange rates.

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Tesco's sales rose 5.3% to £57.7bn last year, ignoring the effect of exchange rates. That largely reflected a 5.1% increase in like-for-like grocery sales. In the important UK market, retail sales were stronger in the second half, as Tesco's prices increased due to inflation. Revenue was lower than the market expected.

Underlying operating profit for the group fell 7.1% to £2.6bn. The higher overall sales were offset by lower volumes, which hurt margins. In-store management changes and the closure of remaining fresh counters in UK stores also dented profit. The smaller Tesco Bank business also saw profit decline compared to last year, because of the non-repeat of a provision release after Covid.

The lower profits contributed to a £144m reduction in retail free cash flow to £2.1bn. Net debt was broadly flat at £10.5bn.

For the new financial year, Tesco expects underlying retail profit to be broadly flat.

A final dividend of 7.05p was announced, taking the full year payment to 10.9p, in line with last year.

The shares rose 1.3% following the announcement.

View the latest Tesco share price and how to deal

Our view

Tesco is managing the weakening consumer landscape about as well as possible.

That's being helped by Tesco's enormous scale. The mature, deeply rooted, nature of its relationships have been a key tool in allowing Tesco to keep its prices down. The strategy relies on being able to offer better all-round pricing than the competition, and Tesco's delivered remarkably well on that in the past couple of years.

Promotions like Aldi Price Match, Low Everyday Prices and Clubcard Prices have helped Tesco retain market share over the past three years, despite discount retailers increasing the scale of their operations.

Tesco's online offering is also noteworthy, with 1.1m orders being filled a week and sales up 60% over pre-pandemic levels. As spending habits continue to normalise, customers are returning to stores and online growth is coming down. But an elevated level of online demand looks sticky, and Tesco's market leading position means it's well positioned to hold onto that.

There are some other things to keep in mind though.

Inflation remains arguably the biggest headwind, though it's certainly not one that Tesco faces alone. From the customers' perspective, increased living costs mean wallets feel tight. Tesco's value focus should mean it can retain customers, but it does mean higher investment in keeping prices low and a further shift toward more own brand products. An acceleration of the cost saving programme, now set to deliver £1bn in savings over 2 years rather than 3, is already helping to mitigate rising costs.

And despite efforts to keep prices low, all of Tesco's increased revenue is from higher overall prices. Volumes are falling, which is unhelpful to margins.

We admire Tesco's continued focus on value. It certainly makes sense in the current climate. But it will be important to map demand from here. A meaningful number of shoppers are swapping to the discount chains and to stem this outflow, Tesco could see itself damaging margins for longer than thought.

Tesco's dividend is of significant interest. A reinforced balance sheet and impressive cash conversion helps underpin a 4.1% prospective yield and buyback scheme. Remember yields are variable and not guaranteed.

For investors willing to accept the risks, Tesco looks like one of the stronger options in the grocery sector with an attractive income potential. Keep in mind, there's no escaping the reality that conditions are challenging, and likely to remain so in the short term.

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: 13th April 2023