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Tesco – profits rise as shoppers feel the benefit of reduced inflation

Tesco’s full-year sales pointed to improved shopper demand as inflation eased.
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Tesco's sales rose 7.2% to £61.5bn last year, ignoring the effect of exchange rates. Performance was helped by rising volumes, which offset the effects of easing inflation in the UK retail market. Revenue was lower than the market expected, primarily due to lower fuel prices impacting overall sales.

Underlying operating profit for the group increased 12.7% to £2.8bn. This was led by stronger than expected volumes and a further £640mn savings. Net debt reduced 6.9% to £9.8bn despite a 3.3% drop in free cash flow, and the proceeds from the sale of Tesco Bank.

For the new financial year, Tesco expects a marginal improvement in retail adjusted operating profit. Retail free cash flow is expected to land within the range of £1.4-1.8bn, a fall from last year.

A final dividend of 8.25p was announced, taking the full year payment to 12.10p, up 11% on last year. A new £1.0bn buyback programme will take place over the next twelve months.

The shares were broadly flat in early trading.

Our view

Tesco’s finished the year on a high with increased profits and market share gains. With inflationary pressures having ‘lessened substantially’, strong growth in the main retail business has helped to offset the fall in revenues from lower fuel prices.

Despite the small decline, investors will be 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 sustain the attractive 4.5% 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, with strong growth across the key business streams of catering and retail. Most of the banking division was sold in the year to Barclays for £700mn, but Tesco have kept the most profitable bits. This portion is set to grow steadily and further diversifies the group's income streams.

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, means it’s exposed to consumers who are feeling the pinch economically. So far this has been managed well. Growing volumes ahead of the market by appealing to both cost conscious customers and those shopping the Finest range is a big ask. Keeping this up and at the right price points is even harder and could have 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, stagnant 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.

The Non-Executive Chair of Hargreaves Lansdown plc is also a Non-Executive Director of Tesco plc.

Tesco key facts

All ratios are sourced from Refinitiv, based on previous day’s closing values. 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
Guy Lawson-Johns
Equity Analyst

Guy works as an Equity Analyst within the share research team, delivering current research and analysis on individual companies as well as broader sectors.

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Article history
Published: 10th April 2024