Tesco - inching forward

Tesco (TSCO.L): Aldi and Lidl continue to make progress in their UK expansion. However, the big boys seem to be whistling louder as they attempt to keep their spirits up. After Sainsbury’s relatively upbeat recent release, we now have Tesco’s interims, to 29^th August 2015. In the key UK market, LFL sales were down 1.1%, but with an improving trend in Q2 at -1.0% against Q1’s -1.5% (and Q4’s -2.0%). Overseas LFL sales were up 1.0%, with Europe and Asia both positive in Q2. Stripping out the stuff that is being sold/shut, sales (constant currency) were down 0.3%, although currency shaved a further 1.6% off. Group operating profit before bad stuff was £354m, down more than half on last year’s interim of £779m, with UK, International and Bank all in reverse gear. Pre-tax profit (pre exceptionals and pension costs) were £158m against £614m, for eps of 1.13p (v 6.11p) and no dividend, as we already knew. A sign that the ship is more stable is that exceptionals were Nil against £563m in the same period last year. Slashed capex came in at £0.4bn v £0.9bn, whilst net debt (including discontinued operations) went up from £7.5bn to £8.6bn, year-on-year, but was barely up from £8.5bn six months ago. Total indebtedness (including operating leases and pension deficit) edged up from £21.7bn to £21.9bn.

Despite all this gloom the new management team cites that customers are responding to their grass roots turnaround with UK transactions and volumes up. The balance sheet is being bandaged with Homeplus (Korea) due to bring in £4.2bn of benefit, no dividend cost, a cheaper DC pension scheme and less capex. They are on-track to meet this year’s expectations, but “we are prepared to invest further [if we] need to enhance the long-term competitive position of the business”. So it sounds like market share etc. will be defended through further P&L pain if the competition send out more gun-boats.

At 191p, the shares are off the September dip into the 160’s. On current consensus eps for FY16 of 7.6p that is a PE of 25.1x, with FY17’s 10.5p being a PE of 18.2x. Clearly the sheer scale of Tesco is an opportunity and a recovery in sales/margins and a return to a meaningful dividend could all drive the shares higher. However, the discounters are still in a sweet spot and my interpretation is that Tesco would respond to fresh price cuts by rivals. A rights issue, whilst not heavily rumoured, cannot be ruled out at some point in the recovery story. As a reminder, they said at the finals: “future dividends will be considered within the context of the performance of the Group, free cash flow generation and the level of indebtedness.” So for income investors, sitting this one out for now is the safest option. (Neil Cumming^, 7^th October 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