Tesco backs itself to make huge profit this year

Tesco (LSE:TSCO) has again cemented its position as the pre-eminent grocer of the British aisles, driven by a relentless focus on both value and quality.

Its appetite for lowering prices for customers is enabled by its sheer scale and strength, falling food inflation, and a significant cost reduction. In turn, this creates something of a virtuous circle, with more customers attracted by the likes of the group’s Aldi Price Match, Low Everyday Prices and Clubcard Prices.

At the same time, it has also honed its upper end offering, with its Finest range continuing to take market share from rivals. Finest sales exceeded £2 billion in the 52 weeks ended 24 February, an increase of 15.7%, with volumes up 9% and the range now in front of 23 million customers.

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Meanwhile, the hub of the business continues to flex its muscles in a notoriously competitive environment. Retail like-for-like sales grew by 6.8% for the year, including an increase of 7.7% in the UK, and the value and volume of market share increased once more to stand at 27.6% (and 34% for the online business), putting clear light between its size and that of its nearest competitors. 

At the headline level, revenue of £68.2 billion represented an increase of 4.4%, although fractionally shy of estimates given lower fuel sales. Adjusted operating profit was largely in line with expectations, rising by 12.8% to £2.8 billion, while pre-tax profit showed an increase of 160% to £2.3 billion after a non-cash impairment charge of around £980 million the previous year dropped out of the comparative figures.

Some of the investment in lowering grocery prices was enabled by a parallel concentration on cost reduction, where £640 million of savings was delivered against a target of £600 million.

Following the sale of the majority of Tesco Bank to Barclays which includes a strategic 10-year partnership, there was an additional special dividend of £250 million, and retail free cash flow of almost £2.1 billion enabled further moves to be made in strengthening the financial position.

Net debt was reduced from £10.5 billion to £9.8 billion in the period, 113 outlets were opened including seven superstores, 60 Express and 27 One Stop stores, with shareholder returns also seeing the benefit, as Tesco announced a new share buyback programme of £1 billion and an increase to the dividend giving a projected yield of 4.2%.

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Inevitably challenges will remain, even though Tesco is on the front foot to face them. Consumers have yet to see the benefits of falling inflation feed through to interest rates, although wage increases have offset some of these challenges. The group’s Home and Clothing unit reported a dip in sales of 3.4%, largely driven by its decision to exit less profitable lines such as large electrical items, although at 7% of total UK sales the decline has a limited impact.

The group’s outlook is cautiously positive, which even at this early stage sets the scene for outperformance as the year progresses. Tesco is expecting adjusted operating profit for the coming year of “at least” £2.8 billion, with retail cash flow remaining in its previously guided range of between £1.4 billion and £1.8 billion.

It will also continue to invest heavily in improvements to its offerings in terms of price and technology, with some of its flagship cards enabling further volume increases to be encouraged by lower and aggressive product pricing.

Given its position, it can be difficult for the group to continue to exceed expectations, but Tesco is showing few signs of fatigue as its presence weighs heavily on competitors. The share price has seen an increase of 9% over the last year, as compared to a gain of 1.9% for the wider FTSE100, and the new buyback programme should additionally be price supportive as it rolls out.

In the meantime, the group’s longstanding position as the preferred play in the sector seems assured, with the market consensus of the shares as a 'strong buy' highly likely to remain intact.

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interactive investor has just teamed up with experts at eyeQ who use artificial intelligence, macro-economic factors and their own smart machine to generate actionable trading signals. Here’s what it says about Tesco: 

“Today’s trading update from Tesco produced good news – profits are forecast to rise this year and the grocer announced a £1 billion share buyback.

“Good company news will cheer investors but, as always, macro lurks in the background. Big picture dynamics like the growth rate of the UK economy, the inflation outlook and what the Bank of England will do with Base Rates are always critical for businesses.

“Right now, the stand-out on eyeQ’s smart machine is that Tesco model value (where it says the stock should be priced) is rolling over. It has fallen 2.78% over the last month and, right now, overall macro conditions say the grocer ‘should’ be trading around 284p.

“The good news is that it’s not far from where the stock is trading now. Put another way, Tesco is behaving largely as it should. The bad news is that the downward trend is starting to pick up some steam. For most of February, model value was just shy of 300p. The deterioration in macro conditions has all happened in the last two weeks.

“Today’s update suggests Tesco is performing strongly versus its peers and looks a good pick for anyone wanting exposure to the sector. But, at the macro level, conditions aren’t looking as upbeat, suggesting patience might be the right approach for now.”