While there were plenty of positives in Tesco’s (TSCO) full year earnings update, operating profits missed estimates and the guidance for the current year was also disappointing.
Investors responded by pushing the shares to the bottom of the FTSE 100 with a decline of 5.8% to 255p.
MARGIN MISS
The UK’s largest supermarket chain posted revenue including fuel sales for the year to the end of February slightly ahead of market forecasts at £61.3 billion.
However, statutory operating profits of £2.56 billion were not only below the £2.81 billion consensus but below the bottom of the range of market forecasts.
Moreover, the company’s guidance for operating profits this year of between £2.4 billion and £2.6 billion was also lower than the lowest analyst forecast.
The firm said its performance would depend on ‘further normalisation in customer behaviour’ from the elevated level of spending during the pandemic, how high its costs were and its ability to offset them, and how much of its profit it needed to reinvest to keep its market share.
DOUBLE-EDGED SWORD
Tesco has done a tremendous job of defending its market share in the past year through investing in low prices and pulling in customers with its Clubcard deals.
The firm claims it has the strongest UK price position in six years thanks to its Aldi Price Match campaign and its Low Everyday Prices strategy which covers 1,600 product lines.
Meanwhile, the number of households using Clubcard has surpassed 20 million with 9 million customers using the Clubcard app, driving more gains in the group’s share of the online grocery market.
This has enabled the group to maintain a share of more than one pound in every four spent on groceries in the UK, while rivals such as Sainburys (SBRY), Asda and Morrison have seen their market share badly eroded in the last year by the unstoppable rise of Aldi and Lidl.
Investing in lower prices comes at a cost, however, which on top of inflationary pressures in areas such as distribution and a very generous pay deal for hourly-paid staff means margins are under pressure.
Shareholders are still doing pretty well out of Tesco, it should be said, with a 19% hike in the total dividend for the year and a further £750 million of share buybacks to come over the next 12 months.
EXPERT VIEW
Clive Black, director of research at Shore Capital and an authority on the retail sector, says the supermarkets are relatively well-placed to deal with ‘what we see as a probable consumer recession in the UK’.
However, ‘the grocery trade cannot be immune from a volume and mix perspective from food inflation at 5%, potentially rising to the 10% to 12% range,’ he warns.
After today’s update, Black has cut his earnings per share forecast for this year by between 4% and 5% and cut his recommendation from buy to hold, adding ‘retaining a more positive stance feels like pushing water up a hill’.
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