What's the Deal?

Tesco Has a $5.7 Billion Question Hanging Over Its Head

Full-year earnings were great, but where are those extra Booker synergies?
Photographer: Jason Alden/Bloomberg
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Tesco Plc, Britan's biggest grocer, has completed its 4 billion pound ($5.7 billion) purchase of cash-and-carry chain Booker Group Plc. But investors hoping for more super-savings from the retail deal are having to wait a little bit longer.

That's not to sniff at the 28 percent increase in Tesco's full-year operating profit before exceptional items, nor the almost 30 percent reduction in net debt and restoration of the final dividend.

Every Little Helps

Tesco's profit is recovering but is nowhere near the heady levels of the past

Source: Company reports

2014 and before are trading profit

But the lack of an upgrade to synergy targets is disappointing. It's still very early days, of course. The deal only completed five weeks ago, and executives might prefer to keep their powder dry for now, especially given the suspicion from some Booker shareholders that Tesco nabbed itself a bargain.

Nevertheless, it's hard for Tesco boss Dave Lewis and his highly-regarded Booker counterpart Charles Wilson to say they haven't had time to ferret out extra cost cuts. They worked on the deal for more than a year. 

Tesco did confirm pretax synergies of at least 200 million pounds three years on from the deal, with 60 million pounds this year. And Lewis said if he could find more savings, or deliver them early, he would. That indicates there may be something in reserve.

Analysts at HSBC estimate that gross synergies could be 500 million pounds, with about half flowing through to pretax profit and the rest reinvested in growth. The bank says this could bring about a new "virtuous circle" for Tesco, whereby cost savings are put back into lower prices. It harks back to Tesco's glory days under CEO Terry Leahy, when it was able to reinvest the benefits generated by its size.

Back in Growth

Tesco's same store sales have been been positive for two years

Source: Company reports, Bloomberg

It would also help Tesco achieve its group operating margin target. The aim is for a margin between 3.5 percent and 4 percent by the 2019-2020 financial year. It's making progress, reaching 3 percent in the second half of its 2017-2018 financial year.

Fattening Up

The acquisition of Booker should underpin Tesco's margin targets

Source: Company reports, Bloomberg

As with the synergies, it's possible the margin goal could be reached early, or exceeded. But there might be some unhappiness that the target hasn't been upgraded or the deadline brought forward.

While Tesco shares jumped more than 5 percent on Wednesday, it's still suffered a sharp de-rating over the past year as investors fretted about the Booker deal. On a price to forward earnings multiple, it's at a discount to smaller rival Wm Morrison Supermarkets Plc.

Booker Burden

Doubts about Tesco's acquisition have weighed on its valuation

Source: Bloomberg

To close the gap, Tesco needs to show the takeover will enhance its recovery, rather than prove a distraction. Its standalone performance is encouraging. But there's still a nagging doubt about the Booker deal that needs to be answered with upgraded synergy forecasts. Under-promising is understandable, but over-delivery is pretty much expected here.

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:
    James Boxell at jboxell@bloomberg.net

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