Tesco - off the ropes but still bloodied

Tesco (TSCO.L): Last Friday’s trading statement for the first quarter to 30^th May 2015 confirmed that trading is showing signs of bottoming out, albeit there isn’t a lot to cheer about yet. Group LFL sales were down 1.3%, but this was the third quarter of improvement (having troughed at -4.9% in 2Q FY2015). Both the UK and International divisions are showing a similar pattern, although Ireland continues to flounder. The UK’s improvement was despite coming up against comparatives based off a major coupon led promotion this time last year. Total sales growth also declined (by 1.0% at constant currency), partly reflecting the marked slowdown in new store openings. It is still the case though that margins are being squeezed, as prices are cut to win back customers’ business. Food price deflation is still helping to make this a torrid time for the sector. The various players are still looking for ways to land new blows. For example, Waitrose have just launched a novel loyalty offer, which is essentially a tailor made price promotion on a range of your choice for each card carrying customer. The underlying problem remains that Asda, Morrison, Sainsbury’s and Tesco have mis-shaped store portfolios, weighted too much towards large sites. In this respect Tesco is the worst off, with its generation of hypermarkets sites resembling a herd of white elephants. The rise and threat of on-line shopping (along with click and collect) is ongoing as customers tweak their shopping habits. And yet, the chatter seems to be swinging around to the range limitations at Aldi and Lidl’s. The newer, more affluent, customers have always chosen to add the discounters to their trip, rather than replace their habitual store. However, as the Big Four sharpen their act up the incentive to visit a discounter on an extra stop or trip is decreasing. So, I will be brave and wonder whether we may be somewhere near the bottom for the established players.

This might not help much with investment though as profit recovery may be slow-paced. Looking at Tesco, the share price has settled around the 220p level, where on consensus eps forecasts of 9p for FY2016, the PE is 24.4x, with no yield support. In FY2017, consensus eps of 11.7p drops the PE to 18.8x. Much of the bitter medicine has been taken and customers seem to recognise the fact that Tesco is shedding some of its arrogance. But with dividends a long way down the board agenda still, this may all be too much like pie in the warming cabinet for income investors, with plenty of reason to play the waiting game. It does seem to me though that the sector looks less toxic than it did a few months ago. (Neil Cumming^, 29^th June 2015)

These comments are not a personal recommendation to deal. Any investments can fall as well as rise in value, so you could get back less than you invest. I may have a financial interest in some of the stocks written about. www.dividendpower.co.uk or e-mail at info@dividendpower.co.uk  Twitter:  @DividendPower