British supermarket group Tesco PLC (LON:TSCO) aims to report an 11th consecutive quarter of like-for-like sales growth in the UK when it reports first-half results on Wednesday.
Tesco's shares hit all-time highs in August, reflecting the confidence felt by investors and shared by the management. The supermarket group grew underlying first-quarter UK sales growth of 2.1% and is tipped to keep the trend up this week after a busy 2018 for the retail giant.
READ: Tesco tries to out-Lidl the German discounters with Jack's
Recent agreements have hinted at continued optimism within the business: the ink on the Booker deal had barely dried when the UK’s largest supermarket chain announced a supply alliance with Carrefour. CEO Dave Lewis will tell you the job is certainly not done, though. Aldi (PRIVATE:ALDI) and Lidl have forced the likes of Tesco and the other ‘Big Four’ supermarkets to trim their prices at a time when input costs have been rising.
In response to those pesky discounters, Tesco recently opened its first discount Jack’s store. The City will be on the lookout for more detail on the plans for the initial roll-out and beyond in the results statement.
11 straight quarters of growth
Though Tesco is expected to report yet another quarter of underlying sales growth in the UK, indications are that trade has slowed somewhat in the second quarter and that cost savings rather than volume growth will drive an improvement in the retail profit margin to around 2.5%. Tesco’s recent private label relaunch, which involved a sizeable investment, and some switching by customers to rival supermarkets are also likely to have contributed to a slowdown in growth.
The Booker acquisition looks set to continue to pay off, however, with like-for-like sales tipped to have grown 14.2% at a margin of 3.75%, according to Swiss investment bank UBS. When the Booker deal was first announced last year, Tesco targeted £200mln of cost benefits, on an annual run-rate basis, within three years and a further £25mln in revenue synergies.
“We see the mid-term path to 3.5-4.0% group EBIT margin (pre-Booker) as underpinned by net cost saves rather than volume leverage and remain sanguine on the big picture, even if this period won’t be the clearest proof point of progress,” UBS analysts said in a note to clients, adding that it expects underlying earnings (EBIT) to come in at around £983mln.
In April Tesco reported a 28% rise in annual profits which pushed the share price to its highest level since 2014 in August, helped by the hot and sunny summer weather. The shares have since dropped off following Tesco’s move to open Jacks, as well as its own discount brand.
“This strategy has raised concerns that Tesco might cannibalise its own business, thus shrinking its margins in the process,” analysts at CMC Markets wrote in a note to clients.
Growing competition
The Carrefour partnership, designed to give both parties more buying power, was a nod to margin pressures. The tie-up is due to formally kick off this month and should bring costs down further, enabling it to better compete with discount rivals and a potentially merged Sainsburys (LON:SBRY) and Asda.
The supermarket group returned to the dividend list last year, after a two-year break, with an interim dividend of 1p and a final payment of 2p. This year analysts are looking for an increase in total payment from 3p to 5.5p.
Of the UK supermarkets, German bank Berenberg thinks Tesco, its top pick in the sector, should continue to benefit from “strong growth” at Booker, while Sainsbury’s should continue to improve heading into the second half, boosted by “peaking Argos synergies”. As for Morrisons, analysts hiked their price target to 250p from 210p as they forecast a 9% rise in underlying earnings in the second half of the year, compared with 4% in the first.
The investment bank still has Morrisons as a ‘hold’, while it has ‘buy’ recommendations on Tesco and Sainsbury’s, with target prices of 295p and 369p respectively.