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Tesco downgraded as analysts discover coronavirus “more of a headache” for supermarkets

Shore Capital analysts downgraded the supermarket group and put their rating for rival Sainsbury's under review as extra costs were estimated at £650-925mln

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Tesco PLC (LON:TSCO) was downgraded by Shore Capital as analysts there and elsewhere said the surge in supermarket sales from the coronavirus seemed have been “more of a headache” than the boost it first seemed.

The FTSE 100 supermarket giant on Wednesday reported results for the year to 29 February 2020, showing lower sales and statutory profits but higher underlying profits for the past year, but also warning about that in the current year it was going to incur “significant additional costs”.

READ: Tesco warns coronavirus shopping boost will be "largely offset" by extra costs

One of the main takeaways for the Shore Cap analysts was about the extra costs from dealing with “feeding the nation” that Tesco estimated at £650-925mln.

Although financial guidance was withdrawn, Tesco said it expects the sales uplift and business rate relief amid the coronavirus outbreak may offset set the higher costs.

Overall, Shore Cap’s retail team downgraded pre-tax profits for the year to February 2021 to “probably flat for retail” and, as Tesco Bank is now expected to be loss-making in the current year, downgraded their expectations for group profits and earnings per share.

On the dividend, the analysts note there has been “some debate”, but the declared 6.5p payout was ahead of its 5.8p forecast, and that there “appears to be progress” with the Asian disposal towards completion before the end of the financial year, amounting to a circa 51p per share payout.

With replacement chief executive Ken Murphy arriving from Walgreen Boots in the autumn, the Shore Cap analysts, led by Clive Black, said “well done Dave Lewis in seeing through your plan” to turn around the group since 2014. 

“We are pleased with the FY2020 outcome and we continue to believe that a tight but attractive investment thesis is in place from which shareholders should benefit in due course, including an ongoing potential boost to earnings from the possible share buy-back programme.”

However, following the outlook statement, Shore Cap removed its ‘buy’ recommendations and moved to ‘hold’ on Tesco's shares, and in light of Tesco's update also placed its ‘buy’ stance on Sainsbury’s under review.

More of a headache than the boost

The results, said Russ Mould, investment director at AJ Bell, are a reminder that the panic buying at supermarkets has significant costs as well as benefits.

“Eye-catchingly these costs, of recruiting and training new staff and bringing on additional delivery capacity, could ultimately total close to £1bn – though they may be offset by business rate relief, ‘prudent management’ and an uplift in sales,” Mould said.

“Growth is only really relevant if it is profitable and the 30% surge in sales in recent weeks may have been more of a headache than the boost it might superficially have appeared to be.”

He said the dividend will provide “some comfort” for investors and that “Tesco is still better placed than many other businesses as demand for the food and essentials will continue through the current period of economic stasis”. 

Richard Hunter at Interactive Investor also highligited that from an environmental, social and governance (ESG) perspective, the company has made many financial contributions, including to staff and local communities, “which could see it favourably regarded once the coronavirus dust has settled”.

He said Tesco “is at an interesting juncture, not least because of the ramifications of the current pandemic”, with the 2019 results “marginally disappointing in some areas”, including the costly transformation being undertaken in Central Europe.

Hunter also noted that the presence of discounters Aldi and Lidl continue to be a thorn in the side of the more established players, while there are also rising threat of competition from the likes of Amazon or a “newly-revitalised” Asda, which he said had all combined to crimp overall profitability, despite 2018 acquisition Booker now accounts for around 11% of group sales.

Tesco shares were down 4% to 214.25p on Wednesday morning, where they are down 16% so far this year.

Quick facts: Tesco PLC

Price: 228.3 GBX

LSE:TSCO
Market: LSE
Market Cap: £22.36 billion
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