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Tesco - strong year, but challenges ahead

Full-year group sales, excluding VAT and fuel, were up 3% to £54.8bn (ignoring the effects of exchange rates) driven by growth across all regions.

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Full-year group sales, excluding VAT and fuel, were up 3% to £54.8bn (ignoring the effects of exchange rates) driven by growth across all regions. Reduced Covid costs and a return to profitability for Tesco Bank helped underlying operating profit grow 58.9% to £2.8bn.

The group warned of "significant uncertainties in the external environment", with 2022 underlying operating profit expected in the range of £2.4bn-£2.6bn.

The board has proposed a final dividend of 7.7p and committed to buying back £750m worth of shares over the next twelve months.

The shares fell 4.6% following the announcement.

View the latest Tesco share price and how to deal

Our View

A strong set of full-year results top off what's been a very promising year for Tesco, with UK & Ireland Retail sales up more than 8% on 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. 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 drive market share gains across the board.

Tesco's online offering is also noteworthy, with 1.2m orders being filled a week and sales up 66% over the last two years. The mammoth growth will likely slow from here, as customers return to stores. But an elevated level of online demand looks sticky, and Tesco's market leading position means its 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 are going to feel tight. That should play into Tesco's value focused hands, but it does mean higher investment in keeping prices low. An acceleration of the cost saving programme, set to deliver £1bn in savings over the next 3 years, should help mitigate rising costs to some extent.

Ultimately, these challenges can't be avoided but what's pleasing is a continued focus on delivering value for shoppers, which is what's set the group in good stead over the next few years.

Tesco's 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 strong year just gone gave management confidence to up the share buyback, which 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, with a clear and focused proposition. Annual free cashflows expected to be between £1.4bn-£1.8bn, a reliable revenue stream and market leading position are all serious benefits that are beginning to feed into the group's above average valuation. Remember though, ups and downs are to be expected given the uncertain broader landscape.

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.

Full Year Results (ignoring the effect of exchange rates)

Retail sales in the UK & Republic of Ireland reached £50.0bn, up 2.2% on a like-for-like (LFL) basis. That was driven by a strong recovery in Booker Catering as hospitality reopened, with LFL sales up 56.1% to £2.9bn. Sales growth in the UK, up 0.4% on a LFL basis, was weighted toward the first half as eating out became more popular in the final quarter. Cost inflation can be felt across the region but a reduction in Covid related costs meant underlying operating profit grew 35.4% to £2.5bn.

Online sales in the UK fell 6.5% as customers returned to stores as pandemic worries eased, sales remain 66.1% up on a two-year basis. The group fulfilled 1.2m orders per week, up 0.9% on last year, offset by a 6.8% fall in the average basket value.

LFL sales in Central Europe grew 2.9% to £3.9bn driven by growth across all areas. Underlying operating profit grew 41.1% to £168m, benefiting from reduced Covid costs and improved sales from full-priced clothing and general merchandise products.

Tesco Bank saw revenue jump 25.4% to £922m, solely due to the acquisition of Tesco Underwriting, without which revenue fell 9.4%. Customers paying down debt and increasing savings meant lower income from unsecured lending. Last year's increased bad debt provisions have been released over the year, helping the group post an underlying operating profit if £176m, up from a loss of £175m.

Retail free cash flow of £2.3bn was up 69.9%, helped by improved profit and reduced pension contributions. Net debt fell by £1.5bn to £10.5bn, with the ratio of net debt to cash profits at 2.5 times at the year-end, down from 3.3 the prior period.

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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Article history
Published: 13th April 2022