Tesco Share Price: Q1 Update Raises Questions About Guidance Forecasts

The underperformance in Tesco (LON:TSCO) share price over the past 12 months doesn’t appear to reflect the significant progress made by Tesco management in turning the business around, in the wake of the accounting scandals of a few years ago.

Tesco full year results from last year were the latest evidence the turnaround plan of CEO Dave Lewis is continuing to reap dividends. A 29% jump in pre-tax profits to £1.67bn, while revenues rose 11% to £63.9bn were significant justification that the recent acquisition of Booker, and the focus on its own brand labels was the way forward in what is an incredible tough food retail environment.

Since the release of the annual numbers in April, Tesco’s share price has fallen over 9% to four month lows, though year to date, it is still in positive territory.

Against such a difficult retail backdrop, Tesco will do well to be able to reproduce the kind of performance we saw last year, in the weeks and months ahead.

This is borne out by today’s Q1 sales numbers, which are a reminder, if any were needed, that the tough retail environment could well remain a drag on profit margins over the next few months. In Q1 like for like sales rose by 0.8%, coming in at £11.16bn, with the UK market only showing a rise of 0.4%. This was a disappointment despite a decent Easter performance, and was quite a bit less than some of the more optimistic forecasts of 0.8%.

The underperformance also calls into question the ability of Tesco to hit its full year guidance revenue target of £65bn, and this appears to be reflected in the decline in the share price in early trade, the shares hitting their lowest levels since February.

The latest Kantar data, outlines the scale of the challenge after the UK’s number one supermarket share dropped to 27.3% at the end of last month from 27.7% a year ago.

This decline has largely been due to the discounters Aldi and Lidl eating into its market share, though the Co-op has also staged a comeback. This competition is only set to increase given yesterday’s news that Lidl plans to open 40 new stores in London as part of a £500m five year expansion plan, that will create 1,500 new jobs.

This morning's news that one if its major competitors, Morrisons, is expanding its “Morrisons at Amazon (NASDAQ:AMZN)” same day online delivery service to more cities across the UK, including Glasgow, Sheffield and Portsmouth is likely to be another pressure point, on already squeezed margins.

The company’s “100 years of value” campaign also helped boost sales, though the discounts being offered may have crimped margins, especially since food price inflation appears to have started to edge higher this year. Expectations are for margins to slip back to 3.2%, from 3.4%, though this should be manageable.

At the end of 2017 Tesco management were able to resume a dividend payment and while it is not at the level it was back in Tesco’s heyday, it is still hoped that the level of dividend can increase over time. With a dividend cover of over 2 there is scope for an increase, and for the dividend to head towards 3%, given that at current levels it sits at 2.5%. This doesn’t seem likely now. If anything this morning’s weaker than expected update is unlikely to make the case for Tesco share price for a move back to the highs of this year.

Tesco is not resting on its laurels, it is already pulling back from a number of its non-core operations, as it strives to keep a lid on its costs. The decision earlier this year to pull out of the mortgage market and offload its mortgage book is just one such example of focussing on its core competencies.

On the downside the topic of executive pay is set to be hot button issue and today’s AGM could see some awkward questions posed about this topic with some investors unhappy with the £4.5m pay deal for CEO Dave Lewis, which included a bonus and a shares scheme. While it is less than the £5.3m he received the year before, it is still awkward optics for a business that is set to cut or redeploy nearly 9,000 staff this year alone..

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