🏬 What Tesco's Results Tell Us About the Retail Industry
It was a volatile week for stocks. Tesco saw its shares rise and fall by as much as 9% in the span of a day. But amidst all the noise, its earnings hint at a brighter outlook for the retail industry.
Hello there! I'm John Choong, Senior Equity Research Analyst at InvestingReviews. Every weekend, I bring a different and unique perspective to the week’s biggest macroeconomic data and stories, and what it means for your investments.
✋🏻 Top 5 Things We’re Watching
🖥️ BRC retail sales monitor shocks to the upside: With economists having expected retail sales values to rise by 1.8% from last year, March’s 3.2% shocked experts, putting an end to 7 months of declining growth.
🚶🏼 Footfall showing signs of stabilisation: While footfall in March was still down from last year, the rate of decline (-1.3%) was up significantly from February’s -6.2%, showing that low retail confidence may be finding a nadir.
🇺🇸 US inflation comes in hot: A hotter-than-expected CPI print across the Atlantic reignited fears of further delays to rate cuts on this side of the pond. The odds of a June cut have since came down to approximately 50% from 60%.
📦 February GDP brightens the UK’s prospects: Real GDP growth of 0.13% was in line with consensus, boosted by a rebounding manufacturing industry. That being said, there were a couple of yellow flags from the report.
📝 Home surveyors feeling most positive since October 2022: Housebuilder stocks ended the week strongly after the lates RICS survey showed improving sentiment. But a pivotal two months lie ahead and could trigger a reversal.
📊 Markets This Week
📈 FTSE 100: 7,996 (↑1.07%)
🇬🇧 FTSE 250: 19,721 (↑0.06%)
🧾 5-Year Yield: 4.043% (↑2.72%)
💵 GBP/USD: $1.25/GBP (↓1.43%)
🎟️ Tesco: 283p (↓2.31%)
🗞️ Sector Roundup
🛒 Food Retail: Tesco impressed after beating analysts’ expectations yet again. Meanwhile, JPMorgan JPM 0.00%↑ gave M&S a handsome upgrade, moving their price target to 330p from 260p, and shifted their stance to Overweight.
🏦 Banks: Lloyds suffered a setback after the lender mentioned its intention of cutting some risk management staff due to a ‘misalignment’ in goals. Despite that, we don’t see this as an issue given how strict the BoE’s supervision arm is.
✈️ Airlines: IAG is facing turbulence in getting the EU to approve its takeover of Air Europa. The acquisition has taken years to get the green light amidst antitrust and anticompetitive concerns due to limited alternatives on key routes.
⛏️ Miners: As gold hit an all-time high of $2,444 and news of China’s economy also showing signs of life, the likes of Rio Tinto RIO 0.00%↑, Anglo American, and Glencore saw their share prices rise by more than 5% this week.
🛡️ Defence: BAE continues to reap the rewards of ever-increasing defence spending. Having doubled in share price since Russia’s invasion of Ukraine, the stock got another upgrade from Deutsche DB 0.00%↑ to 1,440p from 1,290p.
🔮 Tesco May Be Foreshadowing a Retail Boom
As Q2 gets rolling, earnings season is back. There’s a lot that one can ascertain about the UK economy based on what the biggest companies are saying — and it gets no bigger than the UK’s largest retailer in Tesco. Just as we’ve been saying for weeks now, the beginning of the cost-of-living crisis is here, and Tesco’s latest results seem to be backing us up on those claims.
Whether you want to look at the latest numbers as an analyst/ investor, or take a more poetic approach and scan for the number of times the words “cost-of-living” or “inflation” were mentioned as compared to previous earnings calls, the bottom line is that things are getting better. But for the fun of it, here’s a graph of the number of times the above terms were mentioned since FY21 anyway. Spot a trend?
Nonetheless, we’re proud to say that our projection for UK revenue (£44.45bn) was as close as one could get to Tesco's final number. And although our EPS estimate looks off (24.14p vs 23.41p) at first sight, this was due to the sale of Tesco Bank to Barclays BCS 0.00%↑. Including the profits from Tesco Bank, EPS would've been 24.19p, leaving us bang on with our initial forecasts (which included Tesco Bank).
Thus, given Tesco’s impressive results, it wasn’t a surprise to see the board propose a higher-than-forecasted dividend per share. Markets had initially been anticipating an increment to 11.40p, but reacted positively when a bigger dividend was announced. This came alongside an even larger share buyback programme of £1bn, up from last year’s £750m, boosted by the Tesco Bank dividend of £250m.
Building on the positive note, there are also indications that customers are trading up, and doing so at a healthy pace. According to CEO Ken Murphy, Tesco continues to win customers from premium retailers — and those shoppers are spending too. Tesco Finest sales are up 15.7% from last year as customer sentiment improves, with volume growth having returned in the second half of the financial year.
Therefore, when taking the fact that Tesco’s average inflation rate is also lower than Kantar’s average, the firm’s return to volume growth is even more significant than that of the graph below. This has allowed Tesco to return to margin expansion on both an adjusted gross (7.12% vs 6.72%) and operating (4.15% vs 3.84%) basis, thereby resulting in EPS growing by a healthy 14% from last year.
What's more, net debt declined to £9.76bn from £10.49bn. This not only gave the green light for bigger dividends and buybacks this time, but also in the future. With the company’s net debt to EBITDA ratio now at 2.3x (the lowest end of its target), and margins and earnings set to grow further in the coming year, so should shareholder returns. Hence, we reiterate our Buy call, with a higher price target of 315p from 310p.
Meanwhile, for those worried about the potential of higher wages impacting margins in the year ahead, it was a relief to hear Murphy address this on the earnings call, thanks to a wonderful question posed by my industry colleague, Izabel Dobreva.
“Is it fair to assume that those savings (c.£500m) together with the energy should offset or more than offset the wage and other general cost inflation you have for the year ahead, meaning there is further scope for margin improvement in the UK?”
Morgan Stanley Head of Equity Research Izabel Dobreva
“Energy will be a bit of a tailwind. Savings will also help. And as you rightly point out, there will still be a big headwind when it comes to payroll costs, but hopefully we can work really hard to offset one with the other. That's the game plan.”
Tesco CEO Ken Murphy
Consequently, given the group’s outlook for FY25 of expecting more than £2.8bn of retail adjusted operating profit, it would suggest that volumes should gain more traction as the year progresses, with lower energy prices helping to offset higher wages. As such, this suggests a brighter outlook for not only Tesco, but the rest of the retail industry from both a consumer and cost perspective.
When paired with this week’s BRC data surprised too, retail may have already turned a corner. And who knows, it might get even better if those wage hikes don’t end up being as big of a headwind as they’ve been made out to be. But we’ll see, as it’s anybody’s guess at the moment, with earnings growth expected to reaccelerate in next week’s print. It’s all to play for.
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🔎 Data Points to Watch Next Week
👨🏼💼 Unemployment Rate: In line with declining vacancies, unemployment should tick up to 4.0% from 3.9%. A weaker print could lift markets as earlier rate cuts may be back on the table, but be wary of the data’s validity due to small samples.
💸 Average Weekly Earnings (AWE) Growth: Expect a rebound to 5.8% (inc. bonus) from 5.6%, and 6.2% (ex. bonus) from 6.1%. But if a decline somehow shows up, it may ease worries of a significant wage impact in April’s CPI report.
🧺 CPI: Headline inflation should drop to 3.1% from 3.4%, with core to 4.3% from 4.5%. CPI could stay sticky at 0.5% from last month (M/M) due to higher fuel prices, but if core isn’t hotter than 0.3% (M/M), it may help to quash some fears.
🛍️ Retail Sales: Further evidence/confirmation of our thesis that the retail industry is indeed turning a corner, is to be expected. On a month-on-month basis, retail sales volumes should edge up by 0.2%, and 0.7% from a year ago.
🚨 ICYMI, Last Week’s Read 👇🏻
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