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Can Tesco compete with discount supermarkets as cost-of-living crisis deepens?

By David Burrows

08:59, 30 September 2022

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TSCOl
Tesco
2.2935 USD
-0.011 -0.480%
SBRY
Sainsbury
2.272 USD
0.01 +0.440%

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Tesco store in Meir, England
Tesco's share price has come under pressure as economic climate has hardened. Photo: Getty

It is true that even in recession and the midst of a cost-of-living crisis, consumers must buy essentials. To this extent, supermarkets have some protection from the belt tightening forced on consumers.

But within the sector itself there is much fighting for market share as customers become much more cost conscious in their weekly shop.

 Supermarket giant Tesco (TSCOI) reports its first half results next week, and City watchers will be interested to see what numbers it produces. Pricing pressures and competition from discount supermarkets is making the business environment tough.

Giles Hurley, chief executive of Aldi UK and Ireland, claimed this week that the chain had gained 1.5 million extra shoppers compared with last year.

Tesco share price chart

The Tesco share price has weakened considerably over the year from a high of around 303p back in late January to its present level around 200p.

It is not alone in this respect - Sainsbury’s (SBRY) share price shows a similar trajectory.

As Russ Mould, investment director at AJ Bell points out, shares in Tesco are down by a little bit more than 10% over the past year and all of that fall (and more) has come in the past month or so, as confidence has fallen in global stock markets more generally and sterling and the UK market more directly.

“In terms of company-specific issues, shareholders may be fretting a little about ongoing competition in the grocery business.

“According to Kantar Worldpanel, Tesco’s market share is a still-market-leading 26.9%, but that is down from 27.3% one year ago as the discounters Aldi and Lidl have continued to gobble up share,” Mould explains.

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Balancing act for Tesco

This price competition, he argues, is coming at an awkward time because the weaker pound, rising utility bills and higher pay for staff may mean Tesco would like to compensate for those costs with higher prices – while still providing value for its customers.

“This is a difficult balancing act. We all have to eat, drink and keep our houses clean but at the same time we may buy less, or at least trade down through brands, when times get tough,” Mould adds.

Analysts will study the Tesco statement closely for mention of input costs, pricing and margin strategies, as well as looking out for how they may be impacting the reported numbers.

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Mould suggests analysts will look to four key data sets in Tesco’s half-year report.

The first is like-for-like sales growth in the second quarter and first half. At the first-quarter stage, group like-for-likes sales growth of 2% on a one-year basis and 9.9% against three years ago and the pre-pandemic equivalent period.

The UK was down 1.5% year-on-year, wholesales business Booker was roaring back with a 19.4% advance and Central Europe was up 9.0%.

On a headline basis, for the half-year, analysts are looking for sales of £31.2bn against £30.4bn a year ago.

Tesco operating profit

The second is operating profit. Alongside April’s results for fiscal 2022, chief executive Ken Murphy offered forecast adjusted operating profit from the retail business of £2.4bn to £2.6bn for fiscal 2023, with Tesco Bank expected to contribute a further £120m - £160m.

Analysts are looking for a figure toward the low end of that range at £2.6bn down from £2.8bn in the year to February 2022. A year ago, Tesco’s first-half adjusted operating profit was £1.5bn (£1.38bn from retail and £72m from the bank) so that is the benchmark for these interim results”, Mould says.

The third is operating free cash flow, where Tesco has a target of generating between £1.4bn and £1.8bn a year

And the fourth is cash returns to shareholders. Mould points to the CEO refining Tesco’s capital allocation strategy, putting investment in the business first with capital investment running between £900m and £1.2bn a year.

“Capex is expected to come in at the top end of that range in this fiscal year, compared to £1.1bn last time around. The next priority is to maintain a strong balance sheet”.

 He concludes: “After that, Tesco will look to pay a dividend, make any acquisitions and then, finally, return any surplus cash through buybacks.

“Tesco is currently running a £750m share buyback that runs from July 2022 to April 2022 and analysts are looking for an unchanged full-year dividend 10.9p a share. That in turn suggests the first-half payment will also be flat, at 3.2p a share”.

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