A second profit warning in six weeks and hefty dividend cut suggests trading is worse than thought at Tesco (TSCO). Given an ongoing shopper exodus and poor sector sentiment, the grocery giant’s bombed-out shares could struggle to re-rate any time soon, so we turn bearish.
In an unscheduled statement (29 Aug), Britain’s biggest retailer lowered full-year profits guidance again, to trading profits (adjusted operating profits) of between £2.4 billion and £2.5 billion, implying a 28% slump year-on-year. First half profit to 23 August is now expected to be 31% lower year-on-year at £1.1 billion. Shares’ contrarian call on Tesco - (see The Big Debate, 21 Aug) - was mistimed, though we did flag a further profit warning and chunky dividend cut as near-term risks.
The latest Kantar Worldpanel data (27 Aug) shows shoppers continue to spurn the once beloved brand for discounters Lidl and Aldi. Margins are being squeezed by a damaging price war, with Tesco investing heavily in price cuts to woo back disaffected customers. To ease financial pressures, the £18.1 billion cap says it will slash its half-time payout by 75% to 1.16p and pare full-year capital spending on store refits and IT projects by £400 million to £2.1 billion. We expect the full-year dividend to also be cut, potentially a trigger for more investors to bail out if they originally bought Tesco as an income stock.
New chief executive officer Dave Lewis has joined a month earlier than planned to implement a turnaround strategy. He’ll likely update the market at interim results on 1 October but it will probably be too early to expect a major restructuring. The former Unilever (ULVR) man urgently needs to fix the core UK business and there’s big cultural problems to address.
Analysts argue Lewis needs to match the discounters on prices for bread, milk and fresh food and simplify Tesco’s Clubcard loyalty and voucher scheme, a key competitive advantage. There’s also the juggling act of upgrading stores and improving customer service levels - staff morale is thought to be low - while implementing further cost reductions.
Though the turnaround will take time, Shares still believes Tesco can be fixed given advantages including UK market leadership in food retailing and its established non-food and multi-channel businesses, though there could be further bad news ahead. One broker, Deutsche Bank, now forecasts a savage 35% earnings per share slump to 20.91p this year and forecasts a 75% cut in the full-year shareholder reward to just 3.69p.
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We see further downside at 226.75p. Investor sentiment towards the grocery sector is poor and a shopper exodus means further downgrades cannot be ruled out. Avoid for now, although this could be a worthy turnaround story to consider in 2015 if Lewis can win back consumer support.
BULL CASE
• Strong cash generation
• Established online and non-food businesses
• Proprietary brands
• Impressive customer analytics
• Potential value creation through property disposals
• Lots of bad news already in share price
• New management impetus
• More attractive pricing structure on home deliveries
BEAR CASE
• UK margins under pressure
• Poor like-for-like sales
• Brand out of favour
• New finance director won’t join until December
• Further dividend cuts
• Negative sector sentiment
• May take two years to see proper earnings recovery
• Competition also fierce outside of UK