It has been a long path back from the darkness for Tesco PLC (LON:TSCO) but there now looks to be some light at the end of the aisle.
The UK’s largest grocer has been in recovery mode ever since it was plunged into controversy when it overstated profits by more than £300mln back in 2014.
READ: Tesco posts 28% rise in underlying operating profits as turnaround under Dave Lewis continues
Dave Lewis was due to take up his new role as Tesco chief executive in October of that year, but he joined a month earlier than expected and his first job, barely three weeks into his reign, was to tell investors about the accounting blunder.
Drastic Dave
Bosses taking over struggling businesses tend to spill all the bad beans at the start of their tenure – and Tesco, by its own admission, was certainly finding the going tough in a “challenging” market at that point in time.
A few months after that, Lewis bemoaned the “erosion of [Tesco’s] competitiveness” under the previous leadership.
With expectations and the share price both at years-long lows, Lewis had the difficult task of implementing his plans as the beginning of his first full year in charge approached.
At Unilever PLC (LON:ULVR), where he was president of the personal care division before joining Tesco, Lewis earned himself the nickname of “Drastic Dave” for cutting hundreds of jobs and products to simplify the business.
He followed a similar strategy early on Tesco, too, cutting thousands of jobs at the retailer’s Welwyn Garden City head office, while he also made the decision to pull 30% of products from the shelves.
More than just cost-cutting though …
Trimming the fat, so to speak, has been a theme throughout his almost-four-year stay; earlier this year Tesco revealed it would be cutting another 1,700 manager roles and last summer, it axed a further 1,200 Welwyn-based roles.
Away from the cost-cutting, Lewis has also overseen some ingenious ideas. In 2016, the grocer introduced a range of fresh foods labelled with the names of farms that don’t exist.
The City raised its collective eyebrows at the move but Lewis has been vindicated, with Tesco boasting of “consistent strength” in sales of fresh food in its latest results.
Tesco isn’t the only company to feature made-up farm names on its products, it is a ploy also used by German discounters Aldi and Lidl.
Battling the discounters
The success of those two firms is one of the main reasons why Tesco, and other grocers, have been trying to slash their cost base so they can invest more in their price offerings.
All of the ‘Big Four’ (Tesco, Sainsbury’s, Asda and Morrisons) have seen their market shares fall in recent years as cash-strapped shoppers flock to Aldi and Lidl.
Ten years ago, the two discounters barely registered on Kantar Worldpanel’s grocery market share charts, but today, they have a combined share of more than 12% with Lidl now the fifth-largest supermarket chain in the UK.
In response to this tough trading environment, Lewis made a play to snap up Budgens owner and wholesale giant Booker Group.
That £3.7bn deal was confirmed last month after shareholders voted it through and it adds wholesale to Tesco’s three other sales channels (large stores, convenience stores and online).
Back on two feet
Lewis’ various plans, however ‘drastic’, over the past four years have certainly achieved the desired result. Tesco saw underlying profits rise by almost a third to £1.64bn in the year just gone – its highest since the accounting scandal.
Sales in the UK and Ireland – its core market which makes up two-thirds of profits – are particularly strong, while Lewis and his team have also made the decision to back out of unsuccessful ventures abroad.
City analysts expect revenues and profits to continue to rise over the next few years, with pre-tax profits reaching £2bn by 2020.
A future income stock?
A sign of the improvement in Tesco’s health is the dividend, which it scrapped following the mis-statement.
It continued to operate without one for the two years after that, but Tesco brought it back this year.
Management said it would pay a full-year dividend of 3p which it said “reflects [the] improved performance and board confidence”.
That means the projected dividend yield works out at around 2% which, as Interactive Investor’s Richard Hunter notes is “unexceptional”.
But Tesco has said in the past, it will look to pay out around half of its profits to shareholders, so if the business keeps on improving, so should shareholder returns.
Beware Amazon
Investors shouldn’t get too carried away though. The signs are good but its much-praised profits this time around are less than half what it was recording only six years ago.
Tesco has been holding its own against the competition recently as well, but the likes of Aldi and Lidl are unlikely to go away any time soon, while Amazon.com Inc’s (NASDAQ:AMZN) purchase of Whole Foods, suggests it has the grocery sphere firmly in its sights.
“Competition in the grocery market is still fierce, with the discounters Aldi and Lidl piling on the pressure, alongside the likes of Morrison and Sainsbury,” wrote Hargreaves Lansdown analyst
“It’s also hard not to glance at the periphery of the market, and see Amazon limbering up with the purchase of Whole Foods and online grocery trials in selected UK postcodes.”
Tesco shares were up 5.9% to 222.6p in early afternoon trading.