Tesco first half results: What the analysts say

Bernstein

”Tesco recovery is on track. Group operating profit of £759m; 8.0% ahead of consensus of 703m. Even excluding £30 million of property profits, this is still a very big beat.

Tesco UK & ROI operating margin of +2.13%; 7 bps below consensus of +2.2%. However, this comes after consensus had increased leading up to the results. Margin expansion was 32bps YoY showing acceleration along the recovery path.

International growth 71% YoY, driving the operating margin beat and 53.9% ahead of our expectations. The beat on group operating profit is driven by the international. Asia profitability up 24.8% at constant rates and Europe increasing from £17m to £57m at constant rates

Net pension deficit reduced from £5,504m to £2,439m. There are 2 new valuations. The independent triennial is at £3 billion, the accounting version down to £2.4 billion. The accounting version drop is a combination of ‘standard’ changes (asset valuation, experience gains, etc.) and an adjustment to the discount rate, bringing it closer in line with IAS19 guidance (i.e from long dated gilts to a corporate bond equivalent long term yield).

Pension drop in itself warrants a 20% share price increase or 30p on the shares.

Dividend reinstated: interim payment of 1p/share. Assuming a 30% interim payout, this implies dividend for the full year of 3.3p, around 30% payout on our EPS estimate. The reinstatement of the dividend is an important symbolic milestone for Tesco

Group net debt of £3,260m, down £469m from £3,729m in H2 last year and £444m ahead of our expectations (£3,704m). This is driven by strong retail FCF of £586m. Cash beat is driven by working capital, property proceeds and improved profitability. Given cash capex was larger than accrual capex in H1, H2 is set for another strong FCF period, getting it to ~8% FCF yield at this early stage of the recovery.”

CityIndex

Views on full-year profits will almost certainly see a small upgrade

That’s the rationale offered by CEO Dave Lewis, and it’s plausible. Operational and financial efficiency improvement is unabated since he joined in 2014. There is, however, another motivation for a move which has come earlier than many investors were expecting. Tesco shares have sharply lagged those of smaller rival Morrisons this year, and, to a lesser extent the benchmark index, despite group progress across most metrics. And investors have still signalled clear differentiation amongst supermarkets. We think the underlying discount is due to uncertainties over the Booker buy. The CFO said on Wednesday morning that the deal is on track for completion, notwithstanding enhanced CMA scrutiny, with an announcement expected later this month. Since we’ve always seen benefits of the combination as only somewhat better than neutral to begin with we would consequently see the impact of non-completion as moderate. But it is still easy to see why the market has remained cautious around the deal in view of the capacity for distraction. On Tesco’s side, whilst the intended acquisition is already largely funded from cash of around £777m, the new Tesco has an eye to all systemic financial outcomes. Renewed pay-outs will help underpin sentiment for those shareholders who, like us, see the merits of the purchase as less than compelling.

Beyond Booker

Assuming the deal is eventually done, we would expect any share price discount to dissipate. After all, this is the Tesco long-term shareholders have sought for years: one which is consistently delivering better than expected profits, as per the first-half’s 27% rise to £759m. The tailwind for International looking is also increasingly attractive; suggesting views on full-year profits will almost certainly see a small upgrade. Elsewhere, significant pension deficit progress appears to have been widely underappreciated. The most immediate risk for the group is that the CMA may either reject the Booker buy outright or mandate unattractive conditions. Even then, we would still expect the stock to close the year with gains, based on the view that Tesco could scarcely be handling the consumer outlook more adroitly.

 Economist Intelligence Unit

There are some causes for concern

“For Tesco to produce such a sharp jump in quarterly and interim profits against a backdrop of rising costs and intensifying competition is all the more impressive given that the retailer’s sales growth has been relatively modest and below the rate of inflation. Volume sales for the first half, for example, grew by just 0.3%. Underpinning this has been significant work on reversing an erosion of profit margins through cost-cutting, offloading underperforming assets and reducing promotional offers to keep overall pricing competitive. The announcement of a dividend is a clear sign of confidence from CEO Dave Lewis that his turnaround plan is working.

”There are some causes for concern. Currency headwinds have disguised some steep sales declines in Tesco’s international operations, perhaps reflecting that a focus on the UK does come at the expense of other markets. Equally profit was bolstered by exceptional items like property sales and the sale of Tesco’s stake in Lazada, but overall Tesco will be encouraged ahead of the Booker deal that they are outperforming in challenging market conditions.”

JJL

A true testament to the shopping giant’s resilience

“Tesco’s turnaround quite clearly shows that in spite of past struggles, it is a force to be reckoned with. Brexit fuelled inflation has created a problem for other supermarket players, but Tesco has managed its performance by battling to keeps prices low. Not succumbing to such pressures in a challenging market, is a true testament to the shopping giant’s resilience. And, nothing screams confidence more than its announcement to resume dividends to its shareholders with a 1p pay out, which it hasn’t done since 2014.

“We knew that 2017 would be a tough year for retailers with headwinds including rising costs and falling consumer confidence, but results like this reminds us that robust, positive management can help any retailer increase profitable revenue and keep competition on its toes.”

 

Kantar Retail

Speed is the new loyalty in grocery and Tesco is making the right moves to secure a bigger share of shopper wallet

Senior analyst Derya Yildiz said: ”Tesco has been under pressure for more transparency in recent weeks so the retailer will do everything it takes to ensure shopper satisfaction. Shopper experience – both in-store and online to secure shopping trips – is at the core of these efforts.

Speed is the new loyalty in grocery and Tesco is making the right moves to secure a bigger share of shopper wallet. While Sainsbury’s tests a checkout-free payment app and Costcutter trials fingerprint payment, Tesco’s new Tesco Pay+ is a much simpler yet effective move. Tesco replaced the PayQwiq app with Tesco Pay+ which combines payment and loyalty in one app for quick shopping. Many grocers have apps, but few combine these two functions. Tesco can easily roll out the new app with a short testing phase, winning the basket here and now.

But Tesco’s race for speed is not limited to apps. The grocer extended the same-day grocery delivery service across the UK in Q2 and the service is free to Delivery Saver members, mimicking the Amazon Prime membership. As we are counting down for Christmas, Tesco aims to secure the holiday spend ahead of the season with flash deals in key categories like toys. It’s all about taking a good position against the likes of Amazon and Argos, rather than the rest of the Big 4, to win the shopper.

Meanwhile, the Tesco-Booker deal is awaiting provisional findings from CMA at the end of October which will shape the roadmap for the coming quarters. Tesco is ready to comply in the short term for its long-term vision of securing its supply chain through Booker.”

Retail Vision

The giant has woken from its slumber, and then some

Director John Ibbotson said: “The giant has woken from its slumber, and then some. Tesco’s surging profits are a huge achievement and a shot across the bows to the brand’s would-be obituary writers. The timing couldn’t have been more striking too. As the trial begins of three former senior executives accused of cooking the books during Tesco’s bad old days, this barnstorming result shows how far the turnaround has come.

”After seven consecutive improvements in like-for-like sales, Tesco has finally reinstated the shareholder dividend in the clearest sign yet that the rot has been stopped. Dave Lewis has lived up to his ‘Drastic’ nickname and achieved the delicate balancing act of increasing margins while barely raising prices. In the current inflationary environment this is a huge feat and one of the key reasons cash-strapped customers have been returning to the retail giant in large numbers.

“The secret of his success has been to work with fewer suppliers and then use Tesco’s formidable buying power to drive down their prices. The combination of cheaper supplier costs and a gradual reduction of Tesco’s own operating costs have allowed the brand to increase profits in the face of a weakening market and intense competition. It’s back to basics stuff – sticking religiously to delivering a strong food proposition, keeping prices low and improving customer service – but it works.”

Savvy

At the heart of Tesco’s turnaround is cultural change which spans from the boardroom to the shop floor

”Tesco’s reintroduction of the dividend is the latest in a series of milestones that confirms not only momentum, but pace in the retailer’s recovery efforts. Kantar data shows Tesco is growing its market share again and today we see all major financial indicators in positive ground.

”At the heart of Tesco’s turnaround is cultural change which spans from the boardroom to the shop floor and through into supplier relationships. Walk into a Tesco store and it feels like a confident business - whether you’re looking at the pipeline of NPD, keener pricing or, most importantly perhaps, the colleagues who have the spring back in their steps. There is still much to do, but crucially Tesco’s customer experience is improving and its turnaround strategy is paying dividends- both metaphorically and literally.”

Shore Capital

”We see these results as representing further good operational progress by Dave Lewis (CEO) and his team. Following publication we are expecting to upgrade our forecasts with respect to FY2018 PTP and EPS. As such this is welcome news for Tesco’s shareholders and the whole sector to our minds, noting still high levels of what we deem to be misplaced shorting. Tesco has also announced the recommencement of dividend payments with a 1.0p interim pay-out (targeting 2.0x cover in the medium-term), a sign that the group has left the medical ward and so expressing confidence in future prospects. We shall attend the analyst meeting and issue any revised forecasts thereafter but we sense that the market will welcome this update from Tesco.”

Warwick Business School

A symbolic turning point for Tesco

“The period of Dave Lewis has seen the company’s return on capital employed go from -23.7% (2014) to +3.7% (2017), a sure sign of a reversal in Tesco’s fortunes. However, a number of challenges still exist, not least of all expanding its business into India and China, where the competition with Sainsbury’s and M&S is fierce. Also Tesco has fallen behind in terms of small convenience stores, multichannel retailing and non-food product categories, so maintaining growth or even considering any advantage remains tough.

“Also food inflation is approximately 3% - which may increase due to the issues of lower numbers of EU migrants working in agriculture. However, Tesco appears committed to softening the impact on shoppers by absorbing 1%, which sets it apart from rivals Sainsbury’s and Marks & Spencer.

“Nonetheless, this is a symbolic turning point for Tesco, and we should not underestimate how a sense of success can stimulate further growth – perhaps not least of all because of the pride that it’s 460,000 employees must surely feel.”