Like clockwork, Tesco’s group operating profit comes in above the £1.2bn guidance floated in January by a moderate but welcome amount - £80m - as CEO Dave Lewis suggested it would. And the rest of these set of results is largely on the side of being more than satisfactory. The group operating margin is on target at 2.3% and Tesco’s statement suggests that scope is now emerging to hit the 3.5%-4% 2020 margin goal a little earlier. We think it’s also unlikely that investors will look askance at the retail operating cash flow growth of 9% to 2.3bn, or that the group is only somewhat under a quarter of the way to achieving its ‘medium-term’ cost savings target of £1.5bn.
Together with a near elimination of shop floor inefficiencies like availability, and further inroads in range simplification and ‘promotional participation’ down by a third, Tesco (LON:TSCO) has safely retained the impression of having entered an era of being a more tightly run ship, whose nimble and reactive use of data has quietly become the industry standard, once again.
Niggles are of course inevitable in an environment that the group highlights as “highly competitive,” and the intensity of that competition knows no bounds, notes Tesco. It is linking a 12.5% operating profit decline at constant exchange rates in the international division to “intense competition” in Poland, where the group was forced to double down efforts to invest in price, hitting Central Europe profits. The group also offers no relief for the outlook with respect to a retail tax in Poland (suspended pending an EC investigation) having flagged the issue earlier in the year. Tesco’s cover-all caution about “legislative changes” in its European markets is reiterated in the its preliminary full-year report, which is direct enough guidance to expect the central region in particular and perhaps International in general to remain a drag at least into the second half of its financial year.
Closer to home, there’s also no let-up in Britain’s uniquely taxing grocery sector, and the effectiveness of efforts from UK/Ireland management to regain the initiative speak for themselves, it’s difficult to see the group pulling faster and more decisively ahead in the current financial year. In particular, we wonder how much of the 6% fall in typical basket price since 2014 relates to momentum of previous price initiatives.
And whilst laudably eschewing short-term discount hits in favour of focusing “investments on sustainable improvements”, the strategy is at odds with almost real-time competitive opportunism of Britain’s grocery market and may leave the group exposed to at least marginal erosion of recently regained share.
The impact of what Tesco describes as “inflation in a number of categories” therefore remains abstruse. This is one reason for the cautious shareholder reaction this morning to what is a solid set of annual results overall: Tesco has not quite struck a satisfactory tone on the outlook for inflation and the impact on consumer behaviour.
Wider investor misgivings are also emerging over the proposed Booker deal. Our own view on the move is unchanged—we are obliged to regard the deal as largely neutral. Returns on the table from the get go are likely to be in the low single digits and projected synergies look ambitious. We do however, think, that disquiet is growing in the wider shareholder base over the increasingly acrimonious opposition to the deal, which is almost making accusations by institutional groups like Schroders (LON:SDR) that navigating the deal might be distracting, a self-fulfilling prophecy.
Beyond Booker, we think Tesco shares express broader satisfaction with progress in the first complete financial year under CEO Dave Lewis, and we expect the repeated notice that dividends will be reinstated in the current year to go a long way towards recharging Tesco’s share price progress in the months to come.
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