Tesco: what a difference a year makes!

The Ghost of Christmas Past

I see that a year ago my note on Tesco contained the following observation:

“Cutting the dividend has helped to push the share price northwards. That is because the market clearly sees it as a welcome sign of balance and better judgement by the new Tesco management in setting priorities. What the existing long-term, institutional investors want to see is the company defending and restoring its commanding market share and leadership – something which is clearly more critical and urgent at the moment. One adds that concentration on the UK is the crucial endeavour now, because that is the jewel in the Tesco crown. And that is to be seen in the context of top line sales at the moment, rather than profits.”

I also noted that ‘like for like sales’ over the 2014 Christmas quarter were minus 4.2% which represented an improvement on an earlier minus 5.4% in an earlier quarter that year.

Christmas present

In the Christmas period (the six weeks ended 9^th of January 2016) just reported, the company’s management did what was required of them: Group like for like sales grew by 2.1%; UK like for like sales rose by 1.3%; customer satisfaction overall improved by 3% and 5%; customer transactions rose 3.4%; and the volume of transactions increased 3.5%. International like for like sales were reported as up 4.1%.

In the UK the Tesco work force are evidently being taught, at long last, that the customer is not the enemy. A couple of years ago, you did not go to Tesco for the politest shopping experience. If that has changed it is a major advance.

Q3 to November 2015

For the preceding Q3 (the thirteen weeks to the 28 November 2015) Group ‘like for like’ sales were minus 0.5%; UK like for like sales were down 1.5% and International like for like sales were plus 2.9%.

The company has clearly delivered on the market expectations over Christmas, although those for Q3 were not as good; however, Christmas trading last time was a spectacular improvement to Christmas trading a year earlier. One of the reasons for that is the current absence of the product horrors that afflicted the company in preceding years. They included the horse meat scandal of blessed memory and numerous other product problems which haunted the Tesco brand like a demonic and troubling poltergeist. If there was a retail horror story back then, it seemed to involve Tesco.

Whether Tesco was indeed more afflicted by such troubles than its peer group UK competitors, it was always the Tesco name to which such reports got attached by reporters, no doubt thankful for the journalistic theme in which Tesco played the part of the doltish retailer. (It was schadenfreud for Tesco in those days). Looking at the breakdown sales analysis by business, and region by region, we see a diverse picture.

Although the UK improved its ‘like for like’ transactions it was the least impressive picture of recovery in the Tesco Group. Only in the Christmas trading period did UK like for like sales go positive; that is to say, plus 1.4% at Christmas, against a minus 1.5% result in Q3, minus 1.0% in Q2 and minus 1.5% in Q1.

The Republic of Ireland was better in terms of the Christmas like for like sales result which was an impressive 2.9% (around 45% better than in the UK).

Then there was a whole string of uninterrupted, positive quarterly European ‘like for like’ transactions, ending with a ’like for like’ rise of 4.2% at Christmas (more than three times better than the UK figure.

Asia did almost as well as Europe in its ‘like for like’ at Christmas with a positive increase of 4.0%.

The outlook

The current year about to end on 31st January 2016 is a redefining one for Tesco just as it has been for other native UK food retailers. That re-definition will be most eloquently symbolised by a big cut in the annual dividend, although we shall have to wait until the published figures in March to see what that will amount to. When that is confirmed the market can concentrate on the actions being taken by the management to improve matters and stop worrying about the dividend.

The market consensus is for an annual dividend payout of about 5.15p for this year to end January 2016. That would put the shares at 165p on an annual dividend yield of 3.1%. The expectation is then for an estimated 8% increase in that dividend payout to 5.56p indicating an annual dividend yield of about 3.4% for the year about to start. Those estimated dividend payouts are well covered by accompanying, estimated earnings per share of 9.13p for this year and 11.13p for next year, putting Tesco shares on forward price to earnings ratios of 18 times (almost historic) and then around 15 times on the back of an estimated 22% increase in earnings per share.

Unlike it’s exclusively UK competitors Morrison’s and Sainsbury’s, Tesco has had a little help from its remaining overseas activities in Europe and Asia. We are told little in this statement about them and their prospects. We shall have to await the full annual report and accounts in March to learn more. For some years, the international activities of Tesco were, on balance, a drag on group performance. The US business ‘Fresh N Easy’ has gone. Still, Tesco remains an equity investment in UK supermarket retailing with international interests. That can prove a good thing from time to time or a bad thing. This time it has brought advantages just when Tesco needed them. Perhaps Tesco has at last run out of bad luck? No product horror stories in the UK and a positive contribution from overseas.

The Tesco dividend is useful but not competitive and the PER is high(ish). However, if the company can raise earnings per share by over a fifth next year, as the market in consensus is currently forecasting, that is psychologically important.

Having risen from the dead, the shares look to be a well valued “Hold” in advance of the full report, accounts and statement in March. Until now, the German discounters have had it easy, having only needed to take market share with keen pricing and clever marketing. As they took market share, they increased margins.

The Tesco share price may have seen the bottom this January at 137p, pushed there by misinformed bears who are now singed and reportedly rushing for cover. At the moment we appear to have a share with an estimated forthcoming dividend yield of 3.1%, growing at a further estimated 8% next year.