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December 8, 2011

Tesco trading update – what the analysts say

Tesco, the world's fourth-largest retailer, has operations in 11 markets outside the UK but, as it announced its third-quarter trading update today (8 December), much of the interest from The City was on its domestic business, where underlying sales again fell.

By Dean Best

Tesco, the world’s fourth-largest retailer, has operations in 11 markets outside the UK but, as it announced its third-quarter trading update today (8 December) much of the interest from The City was on its domestic business, where underlying sales again fell. Here is a flavour of what leading retail analysts said about Tesco’s recent performance.

“The focus will be on the UK where management describes the early results of its Price Drop strategy after ten weeks as promising, which is not particularly encouraging language. We are cutting our FY12 pre-tax pre-property profits forecast by 6% to GBP3.698bn, which reflects management comments at its H1 results that UK H2 profits would be flat year-on-year and the lack of pick up in UK despite price performance. For FY13, we have cut PBT by 7% to GBP4.1bn. Whilst we see major opportunities internationally, we need to be convinced that its new UK strategy will return the business to growth and are uncomfortable with the number of recent management departures. We are downgrading our recommendation to ‘hold’ from ‘buy'” – Seymour Pierce analyst Kate Calvert.

“Lacklustre by its own standards, Tesco’s trading update mirrors the wider inertia in the sector at present. Apart from the UK business, trading activity in some of Asia encountered difficulties, whilst the potential for the erosion of both market share and margins remains a concern. More positively, the company has implied a stronger start to its Christmas campaign in the UK, whilst both the Central European and US businesses continue to show signs of improvement. This diversification is helpful in the current environment to Tesco’s overall prospects. The shares have struggled to keep pace with expectations of late, having dropped 8% over the last year as compared to a 4% drop for the wider FTSE100. Nonetheless, the company is one with which investors have perennial patience and the general market view remains that the shares are a buy” – Richard Hunter, head of equites at Hargreaves Lansdown.

“The centre of interest within the core business to us is not so much the overall momentum of like-for-like sales but whether Tesco has generated a better volume performance in its food business. We are encouraged to see that Tesco management is indeed stating that it is achieving a stronger grocery volume performance. We should add though that we question whether or not volumes will be sustained if Tesco UK depends upon The Big Price Drop alone. Thankfully, CEO, Philip Clarke, does not think so either, having spelt out at the interim results that Tesco UK also needed to focus improving ranges, service and store experience to improve its performance, work that will mean flat H2 profits year-on-year. Time will now tell if positive core chain volumes will be sustained; if they are then it augurs well for Tesco UK’s profitability and stock valuation” – Shore Capital analyst Dr Clive Black.

“Tesco states it is performing broadly in line with market expectations and their outlook for the year remains unchanged. This should be reassuring to investors in light of Metro’s profit warning earlier in the week. UK like-for-like sales growth remained flat sequentially, declining 0.9%, with space growth of 3.6%. This comes despite modestly harder comps and self inflicted deflation of c.100bps from Tesco’s Big Price Drop campaign suggesting volume growth has accelerated by around one percentage point – with CEO, Philip Clarke, expecting volume to grow further and promising additional phases of the Big Price Drop” – Sanford Bernstein retail analyst Christopher Hogbin.

“The outcome suggests that Tesco continues to underperform peers, in part reflecting higher exposure to the more discretionary non-food category. The Big Price Drop would also have had a slightly deflationary impact on sales. Encouragingly, management says the price reductions are starting to produce stronger volume growth. Trading conditions in UK food retail are expected to remain tough over the medium term, with the consumer staying under pressure and the competitive environment intense (but rational). However, UK inflation is widely forecast to fall back to the 2.5-3.0% range in 2012, so pressure on consumers could start to moderate slightly over the coming year. Tesco can continue to make steady progress in the UK under such conditions, with the business acting as the cash cow to fund growth in the higher growth markets of Asia and Central Europe” – Charles Stanley analyst Sam Hart.

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