Tesco still the one to beat after these Q3 results

A Christmas bonanza had shareholders in the country's largest supermarket chain breathing a sigh of relief. Our head of markets talks us through these third-quarter results.

Tesco (LSE:TSCO) joined in with the Yuletide celebrations which most of its peers enjoyed, as a Christmas bonanza finished off a strong quarter.

Group like-for-like sales increased by 7.9% in the festive period, largely driven by UK growth of 7.8%, with notable contributions from other parts of the business such as Booker and, in particular, Central Europe. The company’s commitment to value and quality, which has been at the top of the agenda for successive recent quarters, culminated in the strong end to this reporting period.

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For the quarter as a whole, Tesco’s aggressive strategy also paid dividends. Group like-for-like sales grew by 5.7% in the 19 weeks ended 7 January, with the UK business bringing the lion’s share of the improvement, especially in fresh foods where an increase of 8.1% was reported. The way in which consumers shop continued to normalise, with sales increasing across its large stores, convenience stores and online by 8.1%, 6.7% and 2% respectively.

At the same time, Tesco’s market share of 27.5% leaves it comfortably ahead of rivals. However, such a dominant position is hard-earned and the group has little intention of easing up the pressure on its competitors. The various parts of its value proposition, such as the Aldi Price Match, Clubcard Prices and Low Everyday Prices continue to throw down the gauntlet, while the company has also announced a price lock until Easter on over 1,000 everyday products in a further response to the rise of the discounters.

Tesco is also set apart in that it has grown its market share compared to pre-pandemic, with third quarter sales also ahead by 14.9% over that period. The momentum which the group is currently enjoying has also resulted in a reiteration of its previous guidance, with adjusted operating profit for the year expected to come in between £2.4 billion and £2.5 billion, propelled by retail free cash flow of at least £1.8 billion.

Such cash generation has also enabled some largesse in terms of shareholder returns, where the previously announced share buyback scheme of £750 million is still in progress and where a dividend yield of 4.7% remains punchy even in the currently rising interest rate environment.

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If there was ever a guarantee in the supermarket sector, it is that competition will remain fierce, especially in the most obvious differentiator of price. The ongoing pressure of general cost inflation allied to a consumer with a keen eye on value means that investments to mitigate cost increases will remain of vital importance.

More positively, as a giant within the sector, Tesco should have the wherewithal to compete, as well as established supplier relationships which help keep a lid on increases.

Similar to its arch rival Sainsbury (J) (LSE:SBRY), a more recent spike in the share price has been enough to damage the repair of the last year. Tesco has risen by 18% over the last three months, but remains down by 17% over the last year, which compares to a gain of 2.3% for the wider FTSE 100 index.

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The shares remain on a lower rating than has historically been the case and have not yet quite managed to recover to pre-pandemic levels. Even so, the company’s focus on value for its customers, coupled with its sheer scale and power, should maintain its position as the one to beat.

The market consensus has marginally softened of late, but remains positive at a 'cautious buy' on the group’s improving prospects.