Tesco's results savaged though some analysts see light at end of the tunnel
Record annual losses from Tesco were widely attacked by financial analysts and City traders but there was optimism that the results showed several hints of a turnaround.
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However in early trading the shares sprang more than 1% higher, with analysts suggesting either a bear-squeeze of previous short trades or a genuine appreciation by investors of Tesco chief executive Dave Lewis's kitchen-sinking transparency and plan to clean up the balance sheet and turn things around.
For the record, the grocer unveiled sales down 3% to £69.7bn in the year to 28 February, with the previous year's profit swinging to the huge loss before tax of £6.4bn, much worse than the £4.5bn-£5bn expected.
This was mostly due to a bigger-than-anticipated £5.6bn of impairments, including £4.7bn on the property portfolio, plus a further £1bn of stock-related charges and restructuring costs.
"Yet another shocker from Tesco"
"To say that Tesco had a nightmare year in FY2015 would be an understatement, an out-turn that would simply have been unfathomable in days gone by," Shore Capital's Clive Black and Darren Shirley said.
But Morgan Stanley said the results were "more or less" in-line with expectations, with Deutsche Bank, one of the grocer's two house brokers, saying group trading profit of £1.39bn was in line with its forecast, with Europe and Asia EBIT below expectations but offset by a stronger than expected result in the UK. Underlying earning per share of 9.42p were 5% below expectations, however.
As part of a plan to clean up the balance sheet, Tesco announced £7.0bn of write-offs, while total indebtedness hit nearly £22bn and the pension deficit has swelled to almost £4bn, requiring a bigger than expected £270m-a-year repayments.
the £6.38bn loss was the worst in Tesco’s 97-year history
Deutsche took an optimistic view: "While there are arguably a few more downward pressures than upward pressures, we don’t expect 2015/16 consensus numbers to move materially on these results. The confirmation of an agreed funding plan for the pension deficit, which isn’t materially more onerous than our current forecasts, is a positive."
Others were much less positive. "Yet another shocker from Tesco," said senior trader Marc Kimsey at Accendo Markets. "Traders are now discounting positive management rhetoric regarding a 'turnaround plan'. Only the numbers will do now and sadly, they are not only disastrous, but deteriorating."
Alex Joyner at Galvan noted that the £6.38bn loss was the worst in Tesco’s 97-year history and highlighted the true magnitude of the grocer's problems. "'Drastic' Dave Lewis says the turnaround plans are working, but investors are hardly going to feel reassured this morning. The collapsing value of its property portfolio has hit the balance sheet harder than expected. Worryingly, the pension black hole has continued to grow and could hit future profitability."
He expressed concern for how Tesco can win back market share with the industry's price wars fiercer than ever and the discounters "cleaning up".
Simon Johnstone, senior analyst at Kantar Retail, saw light at the end of the tunnel.
"While Tesco looks like it’s on a downward spiral with another major dip in trading profits, its planned recovery strategy promises to steer the retailer back on course. A three-pronged attack to improve performance is centred on strengthening the balance sheet, repairing its reputation and rebuilding the brand.
"Today’s record losses of £5.7bn may well have been more than markets expected but in a way they are also encouraging"
"The supermarket giant has proposed further simplification of its property portfolio but it will also need to find a solution to its 'over-spaced' hypermarkets. Creating more collaborative spaces is key, and we expect to see more subletting initiatives to third parties, such as Sports Direct. Downsizing is essential – especially cutting loose any non-profitable aspects of the business."
Although the brand still needs updating in order to reconnect with shoppers, he felt that with plans to increase staff numbers in stores, a more simple and better-available product range, and a lower and consistent message on price, "shoppers could soon have a reason to return to Tesco – potentially heralding the revival of the supermarket chain".
Writing after initial trading had lifted the shares 2% higher in the first hour of trading, Michael Hewson of CMC Markets also looked for the positives.
Cantor Fitzgerald's Mike Dennis estimates Tesco makes profit margin of just 0.5% in UK, versus Aldi's 5% - even though Aldi prices far lower
— Andrew Clark (@clarkaw) April 22, 2015
"Today’s record losses of £5.7bn may well have been more than markets expected but in a way they are also encouraging, as they signal a determination by management to clean the slate and get on with turning the business around, and drawing a line under a pretty awful last couple of years.
"The market certainly seems to think so, given that Tesco remains the UK’s biggest supermarket in terms of size, floor space and purchasing power, and while the young pretenders of Aldi and Lidl are undoubtedly eating its lunch, they look like they starting to run up against the limits of their capacity."
While confident Tesco will be able to easily get rid of its excess real estate over the next few quarters, if they feel the need to do so, he warned the supermarket sector was likely to continue to face squeezed margins over the course of the next 12 months as Aldi and Lidl ramp up their TV advertising campaigns and add new shops on the UK high street.
"The prominence of the reinvestment commitment may temper any belief that margins will recover overnight"
In Morgan Stanley's view, with the customer proposition improving and Tesco experienced recovering volumes in therecent months. "this will likely support margins given operational deleveraging reversing, and Tesco's revised supplier contracts".
Shore Capital's dynamic retail sector duo said that, while the challenges are considerable and that there is no quick fix to Tesco's problems, with little or no hope of achieving the performance levels of halcyon days of old, "we are pleased with the management team that has been put into place, which gives us some confidence of improvement and better times ahead".
They felt Lewis "hasn't put a foot wrong" since he started last year but that with little prospect of income support and a need for the business to demonstrate that trading is improving on an ongoing basis, they saw "limited scope for material share price appreciation at this time".
"Tesco’s recovery is not without risk, and any investor will need to be patient, hoping that the group can go beyond recovery and become a steady state, highly free cash generative multi-channel retailer."
Finally, Tesco's other house broker, Barclays, perceived two clear messages from the results statement: that volume growth is the priority and that any additional savings or outperformance will be reinvested to improve the customer offer and, in turn, boost volumes.
"Entering such a ‘virtuous circle’ is an aim of many retailers, but the cost is rarely cheap – the additional £150m of savings identified by Tesco today seem likely to follow the £250m tranche from January into improving the proposition, not rebuilding short-term margins.
"The single biggest variable in Tesco’s valuation is the long-term level of Tesco’s UK margin (or, more crucially its absolute EBITDA). The prominence of the reinvestment commitment may temper any belief that margins will recover overnight. Tesco’s focus on volume recovery is clear – if achieved, this could transform the perception of its growth profile. However, it als has cautionary implications for its own margins and (potentially) those of the industry."