Shares in Tesco PLC (LON:TSCO) slumped on Wednesday despite the supermarket giant building on its recent revival with a forecast-beating set of results.
For the year to 25 February 2017, Tesco saw underlying profits rise to £1.28bn, up 30% on last year (2016: £985mln) and ahead of the £1.2bn City analysts had predicted.
That was on sales of £49.9bn, an increase of 4.3% on the £47.9bn it reported a year earlier.
Sign up to our daily newsletter to get the best of Proactive delivered straight to your inbox
The numbers will go some way to persuading shareholders that the Welwyn Garden City-based firm is in good shape ahead of its proposed £3.7bn takeover of Booker Group PLC (LON:BOK).
Profit before tax fell to £145mln (2016: £202mln), although this was due to the £235mln hit it took following Monday’s agreement with the Serious Fraud Office and Financial Conduct Authority relating to the 2014 accounting scandal.
UK the driver, international disappoints
Much of the growth came from its UK and Ireland business which saw underlying earnings jump 60% on an actual exchange rate basis to £803mln.
Like-for-like sales in the UK & Ireland grew 1.3% in the second half and up 0.9% across the year as a whole.
That was Tesco’s first full year of sales growth since 2010 in its home market, where it has been losing to customers to German discounters Aldi and Lidl.
It was helped by the recent food prices trend coming to an end which allowed it to pass on cost increases in some of its products to the consumer.
Tesco did acknowledge that pricing pressures continue, although it added it was working hard to minimise the effect on consumers by investing less in short-term promotions and more in “sustainable improvements”.
As expected, the international business, despite all of the potential, continued to disappoint last year with underlying earnings coming in flat at £320mln, although like-for-like sales did rise 1.3%.
The decent figures helped to Tesco to pay down a large chunk – £1.9bn, to be precise – of its debt, with net debt standing at £3.7bn come the end of the period (2016: £5.1bn).
“We are ahead of where we expected to be at this stage," said chief executive Dave Lewis.
"Our exclusive fresh food brands have strengthened our value proposition and our food quality perception is at its highest level for five years.
“At the same time, we have increased profits, generated more cash and significantly reduced debt.”
Shares slump 6%
Despite the seemingly strong results, Tesco shares took a beating throughout Wednesday morning and into the afternoon.
Shortly after 1pm, shares were down 6% to make it the biggest faller on the FTSE 100.
There are possibly a few reasons for that, not least the firm’s pension deficit which ballooned to £5.5bn from only £2.6bn last year. Analysts had been looking for a figure nearer to £5bn.
It not all Tesco’s fault though, with the toxic combination of higher inflation and low interest rates post-Brexit serving to magnify the problem.
That said, analysts had been looking for a figure closer to the £5bn mark.
There’s also the issue of sales growth. Despite posting solid like-for-like figures for the second half of last year (growth of 1.3%), if you break that down into individual quarters, the picture isn’t quite so rosy.
Group like-for-like sales fell from 1.5% in the third quarter to 0.4% in the final three months. Only time will tell if this was just a blip or is the first sign of a worrying downtrend.
Then there’s the controversial acquisition of Booker Group, with some (big name) investors still yet to be convinced.
Speaking of Booker…
Back in January, Tesco revealed it had agreed a £3.7bn deal to acquire Budgens’ owner and cash and carry group, Booker.
Several investors, including Schroders and Artisan Partners, have expressed concerns that the acquisition is too expensive and are also wary that it might derail the company’s recent improvements.
In fact, both of those shareholders, which own a combined 9% of Tesco, wrote to chairman John Allan asking him to pull out of the deal.
Tesco for its part wants to tighten its grip on the near-£200bn UK food market and repeated today that it intends to acquire Booker in order “to enable access to [a] larger, faster-growing market opportunity”.
The group has previously said it is “very confident” it can realise £175mln of synergies, mainly through product and distribution, as well an extra £25mln in growth, figures it repeated again today.
Speaking at today’s press conference, CEO Lewis highlighted that the acquisition will also add wholesale to its three other sales channels (large stores, convenience stores and online) which he thinks can only be a good thing.
The uncertainty from investors though is because most deals don’t go as planned, with Tesco knowing this first hand after its left-field acquisitions of Dobbies and Giraffe among others.
Tesco is still waiting on shareholder and regulatory approval for the transaction, which it expects to get either late this year or early in 2018.
Cost savings
CEO Lewis has previously said that he wants Tesco to generate between 3.5p and 4p in operating profit for every £1 customers spend in-store and online by 2020.
Last year it earned 2.3p, so the boss has his work cut out although he’s set out plans to shed £1.5bn from its cost base to help Tesco get there.
Around £455mln in cost savings was achieved in the past year, while Tesco recently announced plans to reduce the number of night workers – which are paid more due to the unsociable hours – on its books.
Problems in the past?
The better-than-expected numbers should help the retailer to put some of its recent issues firmly in the rear-view mirror.
Tesco will hope the hefty £129mln fine earlier this week and the £84mln it has set aside as compensation finally draw a line under the 2014 accounting scandal.
A sign that the ship is starting to be righted is the dividend. Tesco stopped paying out to shareholders in the wake of those events three years ago but said it intends to resume divi payments this year.
While the numbers show Tesco is bouncing back, only five years ago underlying profits were at £4bn, so there’s still a way to go on the road to recovery.
There are also a couple of other battles on the horizon.
Tesco will have to deal with the anti-trust reviews and shareholder vote on the Booker acquisition, while its suppliers upping prices to cope with higher costs is likely to be another test.
Not out of the woods yet
"Things are looking better at Tesco, but the supermarket’s profits have been diminished by the fines and compensation it has to fork out for mis-stating its profits in 2014. Operationally the company is staging a recovery but it’s not out of the woods just yet," said Hargreaves Lansdown sneior analyst Laith Khalaf.
"The supermarket is facing the prospect of a rise in pension contributions because its scheme valuation is rather inconveniently taking place now, when interest rates are low and inflation is rising, both of which will serve to magnify the deficit.
"Imported food inflation is also coming back into the system, which presents a challenge for supermarkets as the sector is so competitive that raising prices risks losing customers to cheaper rivals."
Shares fell 6% to 185p.
--Updates for additional information, analyst commentary and share price--