Tesco PLC (LON:TSCO) headed lower on Monday after the UK’s biggest supermarket chain had its price target reduced by Kepler Cheuvreux.
Last week, the grocer reported a 24% rise in first-half operating profits to £933mln, lower than the £990mln the City had expected.
READ: Tesco profits dented by sales slump in Europe and Asia
Asia was the biggest drag, with profits tumbling by almost a third in the six months ended August 25.
It was for this reason that Kepler chopped its price target down to 232p (from 261p), with analysts claiming that a “sound UK performance” was overshadowed by the troubles in Thailand.
“While the company had already highlighted the continued negative impact of the end of bulk selling on LFL, no warning was given on a change in negotiations with food manufacturers,” read the note to clients.
Because the Thai market is strongly promotional, back margins – i.e. the manufacturer might give the retailer a small fee for each product sold – are important.
If retailers are trimming their prices to the point where they might not be making any profit at all from the customer, they need to make sure they are making money from the manufacturer.
Margin forecasts adjusted
Tesco doesn’t like this though and has been trying to move to a ‘front margin’ model like in the UK, where the profit comes from the difference between purchase price and sale price, rather than manufacturer incentives.
“This move is leaving margin on the table, as food manufacturers are not moving as fast as Tesco expected.
“While the company expects the margin to recover, the timing is uncertain to us. We thus adjust our forecast accordingly to mirror a 4.6% EBIT margin this year and a slow recovery with 5.3% in 2021.”
Tesco shares were down almost 1% to 212.9p in mid-morning trade on Monday.