Tesco PLC (LSE:TSCO) is bruised after a tough and challenging year but the UK’s largest retailer appears to have the financial strength to ride out all that is thrown its way.
Sales rose but profits fell as the grocer, which unveiled its annual results today, faced a margin squeeze from the potent combination of increased competition and soaring costs.
The German discounters, Aldi and Lidl, are proving a particular thorn in the side of the UK’s traditional food retailers – you know you are doing well when a whole price match campaign is named after you - and rising energy and labour bills have increased operating expenses.
Throw surging food inflation into the mix and it is clear to see why operating profit fell back to £2.63bn from £2.83bn a year before.
Despite the decline the number was at the top end of City expectations while the forecast of flat profit in the coming year was also around 2.5% ahead of consensus.
Whether the food retailer can deliver remains to be seen.
“We are at the most competitive we have ever been,” Tesco claimed in its results statement and herein lies the dilemma.
Because investing in Aldi Price Match, Low Everyday Prices and Clubcard prices promotions comes at a cost with retail margins squeezed by 54 basis points in the year.
Investors will be watching those margins closely. As Sophie Lund-Yates at Hargreaves Lansdown explained: “It was only a few years ago when we saw prolonged single digit margins in the grocery sector as there was a race to the bottom on prices.”
Some respite should be on the way. Energy bills are falling which should help temper the rise in food costs but progress is unlikely to be swift.
Labour costs are likely to remain inflated as the fight for scarce labour continues.
Tesco management also need to up their game in the PR stakes. Accusations of profiteering by its suppliers by the Tesco Chair have led to some frosty relationships while there was also disquiet surrounding fulfilment fees.
The food retailer was also slammed by consumer group, Which?, which said the business’s profits mean it could be doing more to help shoppers.
“These results show Tesco is doing very well during the cost-of-living crisis while millions of its customers struggle to put food on the table due to soaring grocery price inflation,” Sue Davies, the head of food policy at Which? said.
“It’s clear that Tesco and all the major supermarkets could be working harder to make food more affordable for customers who need help," she added.
Sharon Graham, the general secretary of trade union Unite, accused the company of “profiteering”.
She said: “How can it be that, at a time when millions are struggling to feed their families, Britain’s biggest supermarket is profiteering as never before? What sort of country have we become?"
“Frankly, the latest results are obscene,” she claimed.
But aside from these concerns Tesco has plenty of financial muscle to keep the City on side. A further £750mln buyback was announced today and the company has plenty of fire power left.
Retail free cash flow at the year-end was £2.13bn and is expected within a range £1.4bn to £1.8bn in the coming year.
Analysts at Shore Capital believe Tesco is now an effective cash compounder “capable of delivering attractive total sequential shareholder returns centred upon modest underlying earnings growth,” its free cash flow funded dividend, and the recurring buyback.
In the current environment this appears to make sense. Tesco will be hoping it can take its medicine now while holding market share to emerge in a healthy position once the economic outlook brightens.
(Story updated with reaction from Which? and Unite).