Tescos target on margins has divided analysts

Tesco's target on margins has divided analysts

Tesco has insisted its UK margin target is "sustainable" despite concerns among some in the City amid intensifying competition and after the retailer reported lower sales.

The company, which today (5 June) reported a fall in like-for-like sales in the UK, believes it can meet its target for margins as it reshapes the range it offers in store.

Tesco has decided not to sell what it called "lower margin" electrical products and devote more space to other categories, including food, where its performance is stronger.

Speaking to reporters today, CFO Laurie McIlwee said the drop in Tesco's UK like-for-likes was driven by its non-food business. 

"The decline in like-for-likes in the UK is pretty much all to do a decline in GM and non-food. More space will go into clothing, food and health and beauty and they are categories we get more margin out of. That's why were confident that the margin we set for the UK is a sustainable," McIlwee said.

However, some City analysts argue Tesco needs to lower its margin targets. Investec analyst Dave McCarthy, who lowered his forecasts on Tesco earlier this week, believes the retailer's margins are under pressure from lower sales and other factors including the increasing share of the online channel of the overall UK grocery market.

"Management state that it can still deliver the 5.2% targeted margin, despite disappointing and unbudgeted sales falls, but we question the wisdom of this. Tesco’s margin is under pressure and there is a very significant risk that it will be eroded by weak sales and competitor activity. We think it would be better if Tesco were to proactively cut its margin, and put the competition under pressure, rather than see it eroded away," McCarthy said today.

CEO Philip Clarke reiterated Tesco's plans to focus more on higher-margin categories like food. He admitted the move to stop selling electricals would hit sales but added: "We'll still make more profit selling food or a better range of GM in the same space. We said 18 months ago and we repeated it six weeks ago; our UK plan is all about food and related GM and improving the offer for customers."

Elsewhere in the City, others thought Tesco's margin target was achievable. "I know some people around the patch are lowering numbers. They think UK margins are unsustainable; we don't agree with them," Shore Capital analyst Darren Shirley said.

"The concern we maybe would have had around the UK was with the Q1 number being weaker than the number we would be looking for for the full year and what that implies for margin pressure. Philip Clarke was pretty robust in the analyst meeting in highlighting a number of areas that give them some flexibility on margins i.e. a raft of productivity initiatives around the supply chain. The major cause for the poor LFL performance is non-food. Food is broadly flat and probably would have been slightly positive if it wasn't for the horsemeat impact on frozen food and chilled ready meals. The general merchandise business they are moving away from is lower margin anyway," Shirley said.

"We're not trying to be over-bullish on the top-line number but we're not changing numbers. Our positive stance on the stock is not based around short-term trading; it's around the medium-term potential for this more disciplined approach to capital, what that implies for free cash flow and the potential to do more shareholder initiatives down the line. We were not expecting anything different than what came out today."