TSCDF - Tesco Provides Rare Stability In Today's Turmoil

Summary

• Tesco's market leadership in the UK is growing.
• Financial performance is sector-leading.
• Dividend yield is tempting and is likely to be sustainable.

Tesco will maintain UK leadership for years to come

Tesco's (TSCDY) (TSCDF) market share and scale allow it to navigate the ups and downs of the UK economy and of the retail market with more agility than its competitors. The company is the most diversified by far among UK competitors, and the one with the dominant market share - 28% of value market share versus 40% for the following three competitors combined; Sainsbury's (JSNSF) (JSAIY), Morrisons (MRWSF) (MRWSY) and Asda. And this sizeable market share has not only been maintained but has also been increasing over time.

Tesco is unique among its peers. Not only is it the only UK-based grocer with international operations, but also it is the only one with a wholesale and catering business. True, the international business is small, contributing only 5% to sales in 2021, after years of trimming that business. But the wholesale catering business, Booker, is fast-growing, with impressive like-to-like revenue growth of 19% in Q1 2022, and Booker sales represent almost 15% of Tesco's total sales.

Tesco continues to outperform second place Sainsbury's across all parameters

Tesco achieved robust performance in the last two reporting periods; Q1 of FY 2021-2022, and full year 2021. In 2021 , Tesco grew sales by 2.5%, almost doubled adjusted EPS by 88%, increased adjusted operating profit by 58%, and retail free cash flow increased by 70%. An increase in dividends per share of 19% demonstrated confidence that the robust profitability is likely to be sustained.

Tesco still is well ahead of runner up Sainsbury's, across all parameters. Tesco's 2.5% growth in sales in 2021 easily beats Sainsbury's negative 2.6%. Tesco's recorded adjusted operating profit margin of 4.6% compares to Sainsbury's 3.4%. Also, Tesco generated free cash flow of 4% of sales versus 2.6% for Sainsbury's. And the Q1 2022 Trading results did not look any differently. Sainsbury's reported a drop in like-to-like retail sales of 4%, while Tesco reported growth of 2% - a 6% differential. Like-to-like sales in the main UK market dropped by 1.5%. Tesco was keen to highlight that three-year like-to-like sales growth has been a respectable 10%. The three-year like-to-like sales grew by 10% versus Sainsbury's 8%.

Assuring outlook

Tesco's management has enough confidence in outlook, and this confidence transpires well in recent reporting. Management indicated in the annual report that it will work on cost savings - a total of GBP 1 billion over the coming 3 years - to at least match, if not exceed, the impact of cost inflation, thus keeping profitability margins healthy.

Risks are mainly macro

Recession doom and gloom, along with above peers inflation and a collapse in the Sterling Pound have all been headlines for the UK throughout the summer. The combo of doom has given consumers a blow, keeping their confidence at historical lows for the past three months. Retailers across the board have been warning of a slowdown in consumer spending over the past few months. The latest retail sales statistics show that food retail volumes have been stagnant in July, while overall retail sales value has grown by 7.8%, compared to a year earlier. This is not too bad; between April and May, food sales dropped by 1.6%. The stabilization in volume sales combined with growth in value supports sales for a company such as Tesco, and leads to incremental growth in its revenues, profitability and market value.

Is Tesco still a worthy investment?

Whilst noting the considerable macro, I believe there are merits to invest in Tesco for the following reasons. First, Tesco is trading currently around the 1-year lows, with the shares off almost 20% from their peak last year. Market cap to operating cash flow is 5 times versus Sainsbury's 6.6 times. P/E is reasonable at less than 13 times. Tesco has been doing a better job generating cash from its business; operating cash to sales is 6% versus only 2.6% for Sainsbury's.

The relatively safe dividend yield of 4.5% is one of the highest in the FTSE 100. Tesco combines the attractive dividend yield with attractive share buybacks; GBP 740 million planned this year, around 4% of market cap. Tesco is committed to progressive dividend policy, and the company has the resources to keep raising dividends for the foreseeable future.

The combination of reasonable market valuation, high and growing dividend yield, and defensive nature of the business, all provide investors with sufficient reasons to keep Tesco on their good books.

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