Sales Continue To Improve At Tesco; Raises Margin Target

Tesco’s recovery plan appears to be gaining traction after it reported another period of growing underlying sales and set out plans to restore its battered profit margins.

During the 26-week period to 27 August, the group saw like-for-like (LFL) sales in its core UK business grow 0.6%. This follows an acceleration in growth over the period with LFL sales increasing 0.9% in its second quarter compared to a 0.3% rise in the first. Amid heavy deflation in the market, this was driven volume growth of 2.1% with the number of transactions growing 1.6% as the simplification of its product range and price cutting helped it attract some shoppers back from the discounters. Tesco stated that all its store formats – including its once underperforming Extra format – saw an improving trend in LFL sales performance throughout the half.

Overall group sales rose 3.3% to £24.4bn with LFL growth of 1%. LFL sales in Ireland edged up 0.2%, having slowed slightly in the second quarter amid continued price cutting. Meanwhile, its international division saw LFL sales grow 2.6% (+2% in Europe, +3.2% in Asia).

As expected, statutory group pre-tax profit for the half tumbled by 28.3% to £71m as a result of a number of one-off costs relating to the group’s restructuring. However, operating profit before exceptional items jumped by 56.7% to £596m.

In its UK & Ireland division, operating profit before exceptional items more than doubled to £389m, with a margin improvement of 23 basis points on the second half of its last financial year.  The improvement came despite an investment in its products and lower prices. Tesco said that as well as the benefit of strong volume growth across new ranges such as Farms Brands, its overall profitability benefited from a more favourable product mix.

As a result, the group said its first-half profitability was ahead of its initial plan with it on track to make £1.2bn in full-year annual operating profit. Tesco also unveiled a new target for its operating margins to be between 3.5% and 4% by the end of its 2019/20 financial year. In the first half of this year, Tesco’s operating margins came in at 2.18%, a 79 basis point improvement on last year. It plans to achieve its margin target in part through a further £1.5bn reduction in operating costs, to be realised through a more efficient distribution system, a simpler store operating model & goods not for resale savings.

Commenting on the results, Chief Executive Dave Lewis said: “Whilst the market is uncertain, we have made significant progress against the priorities we set out two years ago, stabilising the business and positioning us well for the future.”

He added that it was “just the start” of the group’s recovery but warned that the food price deflation that has been weighing on the entire sector was unlikely to ease off any time soon. He added that Tesco had yet to see an impact from Brexit or the falling pound on the business or costs.

Despite continued concerns about the group’s growing pension deficit, the City welcomed Tesco’s upbeat statement with its share price jumping up nearly 9% in early trading. Analysts at Bernstein said it was a “fantastic set of results for Tesco, delivering on all aspects of the UK recovery”.

Phil Dorrell from retail consultants Retail Remedy said after a third positive LFL quarter in a row and growing profits, Lewis’ Project Reset appears to be doing exactly what it promised. He added: “Tesco’s offer has not significantly changed, it has just evolved. Range rationalisation and flow of goods on the shop floor are simple changes, well executed.

“Price perception has been helped significantly with the Tesco Farms brands. Media mutterings aside, the customer isn’t feeling misled, they are feeling well provided for with a product that meets price and quality needs.

“We are entering the golden quarter for grocery and Tesco will be up against a resurgent Morrisons, a wounded but not down Asda and a Sainsbury’s armed with Argos. Tesco will have room to push further on price if they need to and a rash of offers lined up ready to deploy. Dave Lewis projects confidence and confident he should be.”

Meanwhile, John Ibbotson from the consultancy Retail Vision, commented: “The slickest thing about Dave Lewis’s approach has been its simplicity: reducing prices to regain competitiveness in the core UK business, rebuilding all-important customer trust and strengthening the balance sheet by selling off non-core operations and stores.”

However, he stressed that Tesco could struggle to reach its previous highs. “While Tesco is back on track and could soon be dominant again, it’s unlikely to be the imperious force it once was. While improving, its profits are significantly lower than they were in its heyday.”

NAM Implications:
  • Where at: Tesco are well on the way back in terms of retailing fundamentals, providing benchmark levels as a basis for supplier comparison
  • Where headed: Given an ongoing price war and much of the discounter growth coming at the expense of Asda, Tesco should continue to trade at current levels. However, by March 2017, three overhanging issues will have made an impact i.e. SFO investigation fall-out, £150m shareholder class action and the need for contributions to the pension fund (£5bn deficit).
  • Effect on you: These three issues will be a distraction re. the day-job for Tesco management and NAMs alike
  • Action: Meanwhile, using Tesco’s reported figures, why not compare your brands’ performance with each Tesco ratio, to assess the degree of your positive contribution to Tesco’s comeback performance, as a basis for discussion with your buyer/s?