Tesco’s titanic turn­around

We’re stick­ing with the gro­cer as Dave Lewis’ strat­egy lit­er­ally pays div­i­dends

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Su­per­mar­kets gi­ant Tesco’s (TSCO) im­pres­sive half year re­sults (4 Oct) con­firmed its ea­gerlyan­tic­i­pated re­turn to the div­i­dend list after a three-year hia­tus. We’d hang on for fur­ther gains from the gro­cer’s turn­around, al­though we ac­knowl­edge the shares have re­bounded strongly since June and con­cerns over a planned £3.7bn merger with whole­saler Booker (BOK) re­main.

DIV­I­DEND RE­SUMP­TION

The £15.43bn cap’s half year re­sults proved a mile­stone, a mod­est 1p pay­ment demon­strat­ing con­fi­dence and CEO Dave Lewis guid­ing to­wards a 3p full year div­i­dend. Pre-tax prof­its surged from £71m to £562m, op­er­at­ing mar­gins rose to 2.7% and are on track to hit the 3.5-4% tar­get range by 2019/20, while net debt re­duced 25.1% to be­low £3.3bn.

Tesco’s sales in­fla­tion in the half was around 1% less than the rest of the market, help­ing it at­tract cus­tomers back in droves. Ke­tan Pa­tel, co-fund man­ager of the Amity UK fund, ex­plains: ‘As Tesco has the largest market share of 28%, it can af­ford cer­tain buy­ing pow­ers and can in­vest these sav­ings into pric­ing to keep up with the hard dis­coun­ters.’

In the UK and Repub­lic of Ire­land (ROI) busi­ness, like-for-like sales grew 2.1% for a sev­enth con­sec­u­tive quar­ter of pos­i­tive per­for­mance. We’re hop­ing to see con­tin­ued progress when Tesco re­ports on Christ­mas trad­ing (11 Jan 18).

BOOKER – PO­TEN­TIAL BA­NANA SKIN?

Nev­er­the­less, the medium-term out­look re­mains un­cer­tain given cut-throat com­pe­ti­tion be­tween the big play­ers and Aldi and Lidl. The Booker merger is going through the machi­na­tions of the UK Com­pe­ti­tion & Mar­kets Author­ity (CMA) and some be­lieve Booker could prove a ba­nana skin.

‘How­ever, should it go ahead, we be­lieve the deal presents good value for Tesco,’ coun­ters Pa­tel. ‘The merger will po­si­tion Tesco as a sup­plier to the eat­ing out in­dus­try and con­ve­nience, both of which of­fer su­pe­rior growth com­pared to the food at home its store base serves. As the largest UK food re­tailer, Tesco can lever­age its scale to cut costs, rein­vest in pric­ing and re­main a com­pet­i­tive player and this ac­qui­si­tion will help in­crease scale.’

UBS has a ‘buy’ rat­ing and 270p 12-month price tar­get that im­plies 45% up­side. For the year to Fe­bru­ary 2018, an­a­lyst Daniel Ek­stein fore­casts ma­te­rial earn­ings im­prove­ment to 10.56p (2017: 6.32p), ahead of 13.48p in 2019, where a 3p div­i­dend should rise to 5p per share.

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