Shares in Tesco PLC (LON:TSCO) took a battering after Britain’s biggest retailer missed first-half profit forecasts but there were enough encouraging signs to signal that the slump will only be temporary.
The British supermarket group on Wednesday reported a 24.4% rise in headline operating profit to £933mln in the 26 weeks to August 25 - below analysts' expectations of around £990mln.
READ: Tesco profits dented by sales slump in Europe and Asia
This was, in part, due to lower underlying first-half revenues in central Europe and Asia – like-for-like sales in Europe dipped 1.5% and fell 6.9% in Asia. European sales were hit by the impact of Sunday trading regulations in Poland, which resulted in 13 fewer trading days during the period. Its Asian performance was knocked by the impact of bulk selling and the introduction of government-issued welfare cards, which cannot be used in modern retail chains, in Thailand.
These issues are not a huge deal, according to CMC Markets analysts, who instead point to Tesco's strong showing in its core UK and Ireland markets where it recorded its 11th consecutive quarter of underlying sales growth. Like-for-like sales jumped 4.2% in the second quarter following a 3.5% rise in the first quarter.
“Half-year profits missed expectations, but same-store sales and margins improved and this, on the whole, can be seen as another positive set of interims from Tesco. This looks rather like expectations had maybe been set a little too high, rather than Tesco underperforming,” Markets.com analysts wrote in a note to clients, adding that Tesco’s performance in Europe and Asia had been “patchy” rather than being a cause for concern over the long-term.
Indeed, the retailer’s CEO Dave Lewis said Tesco was “firmly on track” to deliver its medium-term ambitions set out in October 2016 to reduce its costs by £1.5bn, to generate £9bn of retail cash from operations and to improve Group operating margins to between 3.5% and 4.0% by 2019/20. The half-year margin came in at 2.9%.
Lewis' turnaround
Lewis has spearheaded Tesco’s turnaround since 2014 following a period of flagging sales and an accounting scandal plunged the company into chaos. Since then, sales, profits and margins have all been heading in the right direction and first-half operating profit in its home markets jumped 47.6% to £685mln, thanks to a £97mln boost from recently acquired wholesaler Booker.
The acquisition of Booker Group is progressing well, and a recent buying agreement with the French supermarket group Carrefour will give Tesco extra muscle in a market where it may soon face the combined power of J Sainsbury plc (LON:SBRY) and Walmart Inc's Asda. Tesco will also hope its newly launched ‘Jack’s’ budget chain goes down well and halts the rise of the German discounters Aldi (PRIVATE:ALDI) and Lidl.
“Tesco is in good shape to go into battle, and the successful acquisition of Booker combined with improved operating performance, means the CEO Dave Lewis will have a spring in his step,” Hargreaves Lansdown analysts said in a note, adding that the fall in the share price today reflects a reality check for the market, given the stock has jumped a fifth in the last year.
Tesco shares were 8.5% down at 215.20p in late morning trade.
Though the profit miss “rattled the market” according to analysts at The Share Centre, they believe that investors who back Lewis’ strategy and are willing to be patient, are likely to be rewarded further.