Retail giant Tesco set for upcoming battle

Tesco still rules the roost in the British aisles, putting further light between the group and its nearest rivals, even though its dominant grocery position may be tested over the coming year.

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Supermarkets may be about to embark on a trade war of their own, and Asda’s aggressive assault on prices, if it fully happens, will likely shave profits across the sector. This has weighed heavily on the listed supermarket shares, and Tesco (LSE:TSCO) had fallen by 10% so far this year even prior to these results. Added to the fact that expectations progressively increase for this clear market leader and with an uncertain economic outlook, headwinds are likely to remain in evidence.

Even so, the upcoming battle is for Tesco to lose rather than Asda to win. The fact remains that the group’s market share has risen yet again to 28.3%, which is equivalent to that of its nearest rivals (Sainsbury (J) (LSE:SBRY) and Asda) combined. Its sheer scale feeds its appetite for lowering prices for customers through the likes of Aldi Price Match, Low Everyday Prices and Clubcard Prices, while a strong focus on significant cost reduction creates something of a virtuous circle.

In the meantime, Tesco continues to flex its muscles in a notoriously competitive environment, and the range of the group’s offering is not limited to the more cost-conscious consumer. It continues to attack the competition on all fronts and more recently has honed its upper end offering, with a subsequent rise of 15% in Finest sales to £2.5 billion compared to the previous year, helped along by the introduction of 400 new products.

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The group is not complacent in the face of a potentially tightening environment, and has offered cautious guidance in the year to come of adjusted operating profit expected to fall in a range of between £2.7 billion and £3 billion, while maintaining free cash flow in the previously guided £1.4 billion to £1.8 billion target. This leaves Tesco able to keep its powder dry in the face of any assault and it already has plans in place to stifle the competition further despite any attack on prices.

In the meantime, the results do not shoot the lights out, but nonetheless offer much comfort to investors. Revenues rose by 3.5% to £63.64 billion, which was slightly shy of expectations, but adjusted operating profit of £3.13 billion blew past the estimated £3.08 billion and represented an increase of 10.6% on the corresponding period. Retail like-for like-sales rose by 3.1% while online added 10.2% for the period.  

The impact of Tesco’s prodigious cash-generative ability also fed through to improving the financial strength of the business. Net debt was reduced to 9.45 billion from £9.68 billion and shareholder returns were further enhanced. The announcement of a new share buyback programme of £1.45 billion and an increase to the dividend, which leads to a projected yield of 4.1%, are both clear signals of management confidence in prospects, let alone providing more benefit to shareholders.

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Despite the cautious profit outlook, momentum has been generally positive of late for Tesco and the shares have risen by 17% over the last year, as compared to a decline of 3.5% for the wider FTSE 100. Regardless of the fact that investors have given a cool reception to the update, the reaction put little pressure on an undemanding valuation and the market consensus of the shares as a buy and the preferred play in the sector is unlikely to waver.