Lewis' Lesson

Tesco's Christmas Reality Check

Investors should abandon hopes for a straight path to recovery.
At Closing, April 20th
239.40 GBp
At Closing, April 20th
263.90 GBp

After rivals Wm Morrison Supermarkets Plc, and J Sainsbury Plc reported better-than-expected sales over the festive period, Tesco Plc has confirmed that the big grocers had a pretty decent Christmas. 

But its performance -- with U.K. same-store sales up 1.8 percent in the three months to Nov. 26, and 0.7 percent ahead in the six weeks to Jan. 7 -- doesn't look to have been as sparkling as those of its smaller rivals. While it held its own in its core food business, with its market share rising, non-food suffered as it didn’t repeat a promotion that gave customers extra loyalty points.

Surprise Surprise

Wm Morrison and J Sainsbury beat expectations to a greater extent than Tesco

Source: Bloomberg, Company Reports

Add to that a loss of sales momentum and poor international performance, and overall this is a disappointing result. Today's report, and the market reaction, should serve as a warning for Chief Executive Officer Dave Lewis.

True, he's stabilized the retailer's struggles from slumping sales and a profit overstatement in 2014, and the company's a far cry from the trend a few years ago for it to be a clear Christmas loser.  Some elements of the recovery look to be on track. Sales volumes have been rising, and Lewis has to keep that going if he wants to secure the best deals from suppliers -- particularly important when food deflation is fading.

There was also some comfort on Thursday that he'd meet his pledge to double Tesco's operating margin from 2.2 percent in the first half to between 3.5 and 4 percent by the year to February 2020, when he affirmed guidance for full-year operating profit to be at least 1.2 billion pounds ($1.5 billion).

Losing Momentum

Continued same store sales growth wasn't enough to prevent Tesco shares falling

Source: Bloomberg Intelligence, Company Reports

Excludes sales paid for using vouchers

However, he has a long way to go to present investors with the solid pace of growth they're expecting, and Thursday's announcement is a timely reminder Lewis won't be able to tread a straight path to escape from the company's past troubles.

There's no sign yet of the dividend being reinstated. The specter of the company's 5.9 billion-pound pension deficit, and its 4.4 billion pounds of net debt, still loom large.

Richard Cousins, the senior non-executive who was drafted in to bolster the board at the height of the accounting crisis in 2014, suddenly quit last week. Lewis said on Thursday there were no disagreements, but given that the company suffered through a distracting and damaging bout of boardroom turmoil at that time, this is a worrying development.

Punchy Pricing

Forward p/e ratio doesn't reflect the long road Tesco faces to full recovery

Source: Bloomberg

Gadfly has long argued that Tesco's shares have been factoring in a recovery with no bumps in the road. Though shares fell as much as 4.1 percent on Thursday, they're still up about 30 percent in the past year. 

The company trades on a forward price to earnings ratio of 20.9 times, on a par with Morrison and significantly ahead of Sainsbury.

While it didn't have a disaster at Christmas, neither did it live up to the heady expectations that had been built into this valuation. This is a dose of reality that has been a long time coming, and badly needed.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Andrea Felsted in London at afelsted@bloomberg.net

    To contact the editor responsible for this story:
    Jennifer Ryan at jryan13@bloomberg.net

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