Tesco gets City backing after flexing financial muscle

Shares have rallied 40% since October to an 11-month high, and these annual results have been largely well-received. Our head of markets runs through Tesco's latest numbers. 

Tesco (LSE:TSCO) has again flexed its financial muscle in an effort to keep competitors at bay and has had some success in doing so.

Supermarkets are needing to run increasingly hard to stand still, particularly against a backdrop of cost-pressed consumers, high food inflation and a ferociously competitive environment. For Tesco, this is a challenge which has been embraced, partially made possible by the sheer scale and size of its operations, although inevitably this has come at a cost.

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Adjusted operating profit, which strips out a non-cash impairment charge that halved pre-tax profit, declined by 6.9% to £2.63 billion, largely in line with expectations. Revenues were also largely in line at £65.76 billion, an increase of 7.2% on the previous year. The lower adjusted profit number is a reflection of the choices Tesco has made, enabling market share to remain stable at 27%, still significantly ahead of its closest competitors, with the group having managed to grow this share over the last three years.

This has been achieved by a significant investment in the customer offer, such as the Aldi Price Match, Clubcard Prices and Low Everyday Prices, with Tesco passing on less of the inflationary cost pressures than most of its rivals. At the same time, a strong catering recovery at Booker, which represents 13% of overall group sales and a laser focus on costs, where the cumulative target of £1 billion savings by February 2024 is on track, have mitigated some of the pain caused by food inflation and investment in lower prices.

Retail like-for-like (LFL) sales rose at a group level by 5.1%, which is a notable achievement given Tesco’s lofty perch as the UK’s largest grocer by market share. Within this number, Booker LFL sales spiked by 12% and Central Europe by more than 10%, although the latter contributes just 6% of overall revenues. The online offering, which itself accounts for 13% of group revenues, has seen sales stabilise at around 1.1 million orders per week, with overall numbers some 60% higher than pre-pandemic levels.

Tesco also has a broad range of delivery channels which keeps the brand in the minds of consumers and allows a choice of delivery. Quite apart from the traditional stores and a stable online presence, the group now has 2,000 Express and 1,000 One Stop stores, with the digital offering also in rude health – Clubcard app users now number 14 million, of which 11.7 million are in the UK alone.

The many financial plates which Tesco is spinning has also contributed to the overall health of the group. Net debt showed a slight reduction to £10.5 billion, well within the company’s own targets, while a further share buyback programme of £750 was also announced. The dividend was maintained, leading to a yield of 4.3% which remains attractive in the current interest rate environment.

With the current challenges unlikely to abate in the medium term, Tesco is guiding for flat retail profits in the year ahead, being extremely mindful that any lessening of its focus could have an immediate and damaging impact.

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While the company remains the one to beat in terms of size in the UK, growth is also increasingly hard to come by given the higher base. Despite a bounce of 34% over the last six months, the shares remain up by a modest 2% over the last year, as compared to a gain of 3.2% for the wider FTSE100. The three-year performance is rather more respectable, with the shares having added 20%, and investor optimism has not dwindled in the face of such aggressive competition.

The market consensus of the shares as a 'strong buy' is testament to the esteem in which many investors still hold the stock.