Price investments in the UK should intensify in the coming months, but only gradually, concluded the analyst after an investor meeting with Britain’s biggest retailer yesterday (April 16). “Ceo [Philip] Clarke went rapidly during the presentation over the price investments recently made in the UK on items such as milk, eggs, peppers, spring onions and salad tomatoes,” said the analyst.
“Management also indicated that the £200M investment … budgeted for financial year 2015 had not yet been fully implemented in order not to skew the stores’ pricing architecture and could be exceeded if need be.”
Earnings expectations
The other five take-away pointers from the investor meeting concerned: lower consensus earnings expectations, no disposals in international markets other than Turkey, the prospect of hypermarkets’ selling space downsizing, Tesco’s pension deficit may decrease next year and the security of the retailer’s dividend, according to management.
Consensus earnings expectations were predicted to move “a touch lower” after yesterday’s results. “We believe that there is about a £50M upside risk to the latest (£200M) consensus expectations for European operations in financial year 2015,” said Morgan Stanley. That was based partly on lower depreciations, predicted to be between £30–40M following the £734M write down taken at the end of the financial year 2014 and the predicted further erosion of profitability in Ireland in 2015.
Other factors driving performance were likely to be the cost of launching the current account offer by Tesco Bank in the first half of 2015 – estimated at about £20M – and further downward earnings revision for the UK of about £90M. That followed sharp competition in the UK grocery sector and the further price investments.
International markets
Portfolio optimisation was unlikely to be significant in the near future. Tesco is studying strategic alternatives in Turkey, which accounts for 1% of group sales, with a partnership with a local player being one likely outcome. But other international markets – including Korea, Thailand, Poland, and Hungary – were deemed to be solid and disposals were unlikely, according to the meeting.
Cutting the retailer’s hypermarket selling space was likely. Up to 50–100 large stores in the UK could be downsized. “While we believe this is certainly a step in the right direction, we highlight that: a, Tesco has over 750 large stores today in the UK and b, as per Tesco’s ceo comments, the process should be implemented over approximately 10 years,” said Morgan Stanley.
Tesco’s pension deficit increased from £1.8bn in financial year 2013 to £2.6bn in 2014, mainly due to a reduction in real corporate bond yields, with a subsequent fall in the discount rate used to measure Tesco’s liabilities. The retailer’s chief financial officer predicted the pension deficit could decrease next year.
Finally, Morgan Stanley highlighted management’s claim that the dividend was secure. But after yesterday’s results the consensus of expectation will be 7% decline in underlying earnings per share in 2015. But if the retailer’s underlying earnings per share fell by more than 10% in financial year 2015, the company would not be able to maintain a dividend cover “at or above 2x” and the room to manoeuvre without impacting dividend payment would be limited.
Tesco will deliver its next trading statement – covering the 13 weeks ending May 24 – on June 3.
Tesco results: six pointers
- Consensus earnings expectations to move a touch lower.
- Portfolio optimisation unlikely to be material in the coming quarters.
- Clarke more open to hypermarkets’ selling space downsizing.
- Price investments in the UK should intensify in the coming months.
- Tesco’s pension deficit could decrease next year.
- Dividend secure according to management.
Source: Morgan Stanley