3Q18 Update

The UK’s grocery market leader, Tesco, grew comparable sales in its core UK operations by 2.3% in 3Q18, ended November. The figure was slightly below the consensus estimate of 2.4% recorded by S&P Capital IQ, but it marked an acceleration from 2.1% growth in 2Q18 and lapped solid comps of 1.8% in the year-ago period. Tesco’s 2.3% comp was well ahead of the 1.1% reported by rival Sainsbury’s on Wednesday this week but below the 2.8% reported by Morrisons on Tuesday. The companies generated these results in the context of an inflationary grocery market: data service Kantar Worldpanel reported UK grocery inflation of 3.7% for the 12 weeks ended December 31, although Tesco said that it had raised prices less than competitors did. At constant exchange rates, Tesco also noted the following in 3Q18:

• Ireland comp growth accelerated to 3.3% from 2.0% in the prior quarter.
• Central Europe comps grew by 0.8% compared with 0.6% in the prior quarter.
• Asia comps fell by 9.6% against a 10.7% decline in the prior quarter.
• Group comp growth stood at 0.9% versus 0.6% in 2Q18.

Excluding fuel, total group sales grew by 1.8% in the quarter, with total UK sales up 2.5%.

Six-Week Christmas Update

For the subsequent six-week Christmas period, ended January 6, Tesco reported the following (all figures at constant exchange rates):

• UK comp growth slowed to 1.9%.
• Ireland comp growth strengthened further, to 4.0%.
• Central Europe comps came in at 0.2%.
• Asia comps declined further, to (13.8)%.
• Total group comp growth slowed to 0.1%.

Excluding fuel, total group sales grew by 1.8% in the six-week Christmas period, with total UK sales up 2.1%.

Management Commentary

The company hailed a “strong third-quarter performance” in the UK and Ireland and pointed to what it said was an outperformance of the UK market in comparable sales and volumes. Management highlighted UK growth across formats in 3Q18: the Extra hypermarkets, which had previously been a drag on growth, saw comp growth of 1.8%, which the company lauded as the format’s strongest quarterly growth in recent years. Tesco grew its convenience store comparable sales by 2.3% and its online grocery sales by “over 5%” in the quarter. For the six-week Christmas period, UK growth was driven by comp growth of 3.4% in food and 3.7% in fresh food, with fresh-food demand accelerating further in the week leading up to Christmas Day. This growth was offset by a drag in general merchandise sales and disruption in tobacco supplies due to the collapse of supplier Palmer & Harvey. The company noted that it had passed on less inflation to its customers than its competitors had to theirs. CEO Dave Lewis said, “We are confident in the outlook for the full year and are firmly on track to deliver our medium-term ambitions.”

Outlook

The company provided no new guidance. At the half-year point, management provided the following guidance:

• The company remains on track to reduce costs by £1.5 billion, generate £9 billion of retail cash from operations and improve its operating margin to 3.5%–4.0% by fiscal 2020.
• Capital expenditure in the current fiscal year is expected to be £1.1 billion. The company expects it to be £1.1–£1.4 billion in future years.

For the current fiscal year, analysts expect Tesco to grow revenues by 2.7%, to £57.45 billion, and increase EBIT by 22.5%, yielding an EBIT margin of 2.7%. The consensus estimate calls for adjusted pretax profit to climb 36.9% and for diluted EPS before exceptional items and net pension finance costs to total10.1 pence compared with 7.9 pence in FY17. The company will report full-year results on April 11.