Tesco Is the Best- Positioned Grocer in the Coverage

Business Strategy & Outlook:
Tesco, the largest grocery retailer in the United Kingdom in terms of sales and store network, has successfully completed an ambitious turnaround. It has seen one of the worst times in its history over the past decade, including an accounting controversy in 2014 and a subsequent decline in profits and growth owing to the advent of discounters in the U.K. food retail business. The firm is largely focused on enhancing the in-store experience, providing new own-brand products (entry-level and fresh produce), and re-evaluating supplier connections (smaller base and longer-term partnerships). The turnaround strategy focused on the company’s core strengths: food size and well-documented purchasing power.

Tesco’s ability to better control supplier-related cost inflation, along with its superior cost-saving measures, has enabled it to not only balance competition challenges, but also boost margins and price position (via the Aldi Price Match plan) relative to its competitors. The concerted efforts of management to convert these scale advantages into profitable expansion were fruitful. In the future, the group shall generate more normalized levels of profitability, albeit below historical standards. Tesco outperforms most of its Big Four competitors (Sainsbury’s, Asda, and Morrisons) on key indicators like grocery volume, like-for-like sales growth, and large-store sales growth, proving that its approach is succeeding. Tesco’s Booker is the major food distributor in the U.K., with a presence in both the retail (Symbol and Independent) and catering industries. This is consistent with the company’s long-term strategy to increase scale by consolidating its supplier base and indirectly increase food sales through Booker’s overlap in the food sector.

Financial Strengths:
Tesco is in solid financial condition. At the end of fiscal 2022, net debt/adjusted EBITDA (including operating leases) was 3 times. The operating lease liability is around GBP 7.5 billion, and the net pension shortfall is negligible. The dividend was reintroduced in fiscal 2018 (expected around GBX 11 per share for fiscal 2023) after being suspended when earnings dropped in 2015. Management has also implemented stricter financial discipline, enhanced working capital, and ceased the battle for space. Dividends might expand in parallel with underlying EPS growth at a payout ratio of 50% over the next five years (from slightly less than GBX 10 per share to about GBX 14 by 2027). Given the sector’s low growth prospects and Tesco’s established presence, the grocer to is able to finance its development and store maintenance with capital expenditures below 2.0% of sales. Tesco generates free cash flow at a rate that is significantly higher than the industry average, as a result of the recent improvement in profitability. Free cash flow to the firm is expected to account for close to 3% of sales on average through fiscal 2027. In recent years, Tesco has repositioned its operations, including withdrawing from less lucrative areas, which has helped reduce its debt. It also owns property, worth about GBP 22 billion at the end of fiscal 2022, which could be shed to generate cash if needed, though it has been doing the opposite recently by acquiring more stores to rid itself of inflation.

Bulls Say:
As the largest grocer in the U.K. in both the online and offline channels with almost 100% coverage and a network of more than 3,500 stores, Tesco should be able to use its scale to drive results in ways subscale peers cannot.
An early mover in the online channel, Tesco not only holds a dominant market position (35% online grocery share) but also operates profitably on an EBIT level, thanks to scale.
Management is successfully repositioning the business in terms of pricing, in-store experience, and operating efficiencies.

Company Description:
Tesco is one of the largest food retailers in the world, operating thousands of stores in the United Kingdom, Ireland, and Europe. It recently sold its Asia operation. According to Kantar, Tesco is the market leader in the U.K. with a share around 27%, roughly double that of Asda and Sainsbury’s. Tesco operates a core supermarket business in addition to convenience and neighborhood outlets. With a 35% digital market share in the U.K., the company holds a dominant position online. Tesco gained exposure to the cash-and-carry and out-of-home delivering industries with the landmark GBP 4 billion acquisition of Booker in 2018.

(Source: Morningstar)
DISCLAIMER for General Advice: (This document is for general advice only).
This document is provided by Laverne Securities Pty Ltd T/as Laverne Investing. Laverne Securities Pty Ltd, CAR 001269781 of Laverne Capital Pty Ltd AFSL No. 482937.
The material in this document may contain general advice or recommendations which, while believed to be accurate at the time of publication, are not appropriate for all persons or accounts. This document does not purport to contain all the information that a prospective investor may require. The material contained in this document does not take into consideration an investor’s objectives, financial situation or needs. Before acting on the advice, investors should consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation, and needs. The material contained in this document is for sales purposes. The material contained in this document is for information purposes only and is not an offer, solicitation or recommendation with respect to the subscription for, purchase or sale of securities or financial products and neither or anything in it shall form the basis of any contract or commitment. This document should not be regarded by recipients as a substitute for the exercise of their own judgment and recipients should seek independent advice.
The material in this document has been obtained from sources believed to be true but neither Laverne and Banyan Tree nor its associates make any recommendation or warranty concerning the accuracy or reliability or completeness of the information or the performance of the companies referred to in this document. Past performance is not indicative of future performance. Any opinions and or recommendations expressed in this material are subject to change without notice and, Laverne and Banyan Tree are not under any obligation to update or keep current the information contained herein. References made to third parties are based on information believed to be reliable but are not guaranteed as being accurate.
Laverne and Banyan Tree and its respective officers may have an interest in the securities or derivatives of any entities referred to in this material. Laverne and Banyan Tree do and seek to do business with companies that are the subject of its research reports. The analyst(s) hereby certify that all the views expressed in this report accurately reflect their personal views about the subject investment theme and/or company securities.
Although every attempt has been made to verify the accuracy of the information contained in the document, liability for any errors or omissions (except any statutory liability which cannot be excluded) is specifically excluded by Laverne and Banyan Tree, its associates, officers, directors, employees, and agents. Except for any liability which cannot be excluded, Laverne and Banyan Tree, its directors, employees and agents accept no liability or responsibility for any loss or damage of any kind, direct or indirect, arising out of the use of all or any part of this material. Recipients of this document agree in advance that Laverne and Banyan Tree are not liable to recipients in any matters whatsoever otherwise; recipients should disregard, destroy or delete this document. All information is correct at the time of publication. Laverne and Banyan Tree do not guarantee reliability and accuracy of the material contained in this document and are not liable for any unintentional errors in the document.
The securities of any company(ies) mentioned in this document may not be eligible for sale in all jurisdictions or to all categories of investors. This document is provided to the recipient only and is not to be distributed to third parties without the prior consent of Laverne and Banyan Tree.