Tesco's retail sales were up 6.4% in the 19 weeks to 6 January. The group enjoyed its best ever Christmas. Growth is being helped by price cuts, and Tesco increased market share over the period. Both UK and European sales increased, as did wholesaler Booker, led by retail as tobacco declined.
Trading has been better than expected and full year guidance has been upgraded. Retail adjusted operating profit is now expected around £2.75bn, above previous guidance range of £2.6-£2.7bn.
The shares were unmoved following the announcement.
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Our view
Tesco has come out of the festive gates swinging. Despite ongoing pressure on incomes, especially from lower earners, Tesco's third quarter and Christmas trading has surpassed expectations. Full year profit expectations have been improved as a result.
Investors will be especially pleased to hear of the £2bn in retail free cash flow due to pump round the business this year, helping to underpin the group's ability to invest in staying competitive, and helping sustain the attractive 4.2% prospective dividend yield. No dividend is ever guaranteed.
Tesco's 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 further diversifies the group's income streams. There are rumours the business could be sold off, but this isn't a certainty.
But for all the positives, there are things to keep in mind. Aldi and Lidl may not be an existential threat, but they are nabbing shoppers from bigger names. The wider pivot to value offerings, including in Europe where Tesco has a substantial footprint, could keep a lid on progress in the face of a consumer slowdown and volume weakness. The strong value proposition means Tesco is exposed to consumers who are feeling the pinch economically. keeping them shopping with Tesco and at the right price points, is a big task, and also has implications 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 leaves something to be desired.
Tesco's more reliable revenue streams, market-leading proposition and income potential shouldn't be overlooked. We don't see the valuation as overdone. Sentiment will be driven by how margins look over the medium 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.
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