Tesco plc (LON:TSCO) has reported its strongest quarterly UK sales growth in seven years as the supermarket's turnaround continued and as it avoided passing on rising inflation to consumers.
UK like-for-like sales increased 2.3% in the 13 weeks to 27 May, driven by a 2.7% gain in food. Analysts had expected an increase of 2.2% in the first quarter following a 0.7% rise in the fourth quarter.
The company said it achieved particularly strong volumes in fresh food with a 1.6% increase, as Tesco reduced prices of fruit and vegetables and on more than 200 other health foods.
Growth in the core UK business helped to offset a decline in its international division following the decision to discontinue unprofitable bulk selling in Thailand, with group like-for-like sales rising 1.0%. It marked the sixth consecutive quarter of growth across the group.
Shares in Tesco rose 1.36% to 182.45p initially before falling back 0.53% to 179.0p in late morning trading.
Tesco asks suppliers to keep prices low amid rising inflation...
Tesco said it has been working with its suppliers to address rising inflation to ensure price reductions on fresh food and healthy products.
"In tough market conditions, we have stayed true to our commitment to helping customers - working closely with our supplier partners to keep prices low,” said chief executive Dave Lewis.
“Customers have responded by doing more of their shopping with us and as a result we continue to grow volumes, particularly in fresh food.”
A weaker pound following last June’s Brexit vote has pushed up import costs. Tesco has been putting pressure on suppliers to absorb these costs instead of raising prices.
Last year Tesco was engaged in a dispute with Unilever over the consumer giant’s decision to increase prices of its household brands, including Marmite and Ben & Jerry’s. Unilever halted deliveries to Tesco after the grocer refused to accept price rises of about 10% for a range of its brands. The row has since been resolved and the products have been returned to Tesco’s shelves.
Tesco's margins to come under pressure, analysts warn...
Neil Wilson, senior market analyst at Tesco, said: "A focus on keeping prices down despite rising inflation (think Unilever spat) is paying off, particularly in fresh food where volume growth stood at 1.6%.
"Certainly the market is moving from deflationary to inflationary, but the question is always profitability and margins. As long as Tesco uses its muscle to keep the lid on costs it should continue to benefit....”
Laith Khalaf, senior analyst at Hargreaves Lansdown, said the recovery is continuing at Tesco despite the squeeze on consumer incomes from weak wage growth and increasing inflation.
However, Khalaf warned that the "going was still tough".
"....the sector is highly competitive and a rising pound will put pressure on supermarket margins, so it remains to be seen just how much those higher sales will feed through into profits."
Supermarket rivalry...
In addition to inflationary pressures, Tesco has also faced the challenge of fierce competition between UK supermarkets as they lose market share to discounters Aldi and Lidl. Tesco and the other of the ‘Big Four’ supermarkets, including J Sainsbury (LON:SBRY), Morrison Supermarkets plc (LON:MRW) and Asda, have been engaged in a pricing war.
Tesco said it continues to streamline its business to help reduce its cost base by £1.5bn. As part of the plans, the group closed its Welham Green and Chesterfield distribution centres in March and April, respectively.
“Investors will also be pleased to hear that Tesco’s £1.5bn cost-cutting plan remains on track and the combination of costs down and sales up will boost hopes that the company can reach Mr Lewis’ 3.5% to 4.0% operating margin target by 2019-2020," said Russ Mould, investment director at AJ Bell.
However, Mould said the latest data from Kantar Worldpanel showed that Tesco lost market share, falling to 27.8% from 28.3%, while sales growth for May paled next to Aldi and Lidl.
"The grocery business therefore remains as competitive as ever and the US and European markets offer plenty of evidence that the discounters are not going to go away," he said.
Tesco's restructuring efforts....
In April it agreed to sell its opticians business to Vision Express. A month later it agreed a partnership with Dixons Carphone to roll out concession trials in some of the supermarket’s largest stores. Technology retailer Currys PC World, owned by Dixons Carphone, opened outlets within Tesco stores.
In June last year the company agreed to sell its Giraffe restaurant chain to the owner of Harry Ramsden's restaurants, Boparan. At the same time it announced it was offloading its garden centre chain Dobbies to a group of investors led by Midlothian Capital Partners and Hattington Capital.
UK watchdog investigates Tesco's proposed Booker takeover
Tesco is now trying to push through plans to buy wholesaler Booker, the UK's largest food wholesaler and owner of the Premier, Budgens and Londis store brands. The Competition and Markets Authority is investigating the £3.7bn takeover to assess whether it could reduce choice for shoppers and for small stores supplied by Booker.
Tesco made no mention of the deal in its trading update today. Some of Tesco's investors have objected to the takeover on worries the deal will damage Tesco's turnaround and take the focus away from its core supermarket business.
Daniel O’Keefe, of hedge fund Artisan Partners, and City investment giant Schroders publicly spoke out against the aquisition in March. Earlier this month O’Keefe told The Telegraph there was now widespread dislike and apathy for the acquisition among Tesco’s other investors.
“I have spoken to shareholders, I would say I haven’t spoken to anybody that likes the deal,” O’Keefe said.
“My sense is that you have shareholders who are sort of wavering between indifference and outright distaste for the deal, yet most of whom are unwilling to speak up.”
Khalaf said the proposal to take over Booker raises concerns given its "shaky backdrop" but believes continued momentum in the core business will help shore up shareholder value.