Louise Cooper Finance economics markets retail business

Running Hard to Stand Still – Tesco..

Wednesday, October 4th, 2017

Wednesday 4th October 2017
Tesco has reinstated a token 1p a share dividend today with its Interim results.  This is a significant milestone.  Boards hate cutting dividends even more so in a extreme low interest rate environment as shareholders (who of course own the company) desperately need income and will put pressure on Boards to provide in the form of dividends.  

Tesco was considered a core holding of UK based dividend or income fund for a long time.  By 2011 Tesco had a track record of 27 years of consecutive dividend increases and was paying 14.76p a share.   But then things began to go wrong.

In 2013 Tesco announced it was exiting Fresh and Easy in US at a loss of around £1bn.  It reduced its International expansion plans and then the UK market became far more competitive.  It lose billions from its stores and former Executives are now on trial for fraud.

 Despite this deteriorating performance it kept its dividend at 14.76p a share unchanged in 2012, 2013 and 2014 despite these pressures on cashflow.  Finally in August 2014, Tesco cut the dividend by 75% and then cut the final dividend to zero in 2015 so that Tesco paid nothing at all to shareholders for the two financial years to February 2016 and 2017.

So today’s step is hugely important as a signal by the Board that things are now getting better. 

This is an interim 1p dividend.  Assuming the final dividend is 2p (double the interim – not unusual), then the dividend yield on a share price of 188p, is still small.  3p/188p is only a 1.6% dividend yield compared to a FTSE100 average of 4%.

The UK figures show how it is: UK transactions +0.4% and volumes +0.3%, that is not much growth.  And as the number one player, with a market share of 28%, Tesco can’t grow much further.   Its the curse of being the largest player (ask Lord Wolfson about his experience at Next).  

Tesco can only grow if the entire food retail market is growing.  There have been signs in the alst 6-12months that long into this economic recovery, consumers are willing to splash out a little more cash on their weekly grocery bill.  A rising tide has lifted all ships.  But that tide may soon go out again.  With little wage growth and inflation at almost 3% (and above wage growth) consumers are managing to keep spending only by becoming more indebted. 

And the wider economy is slowing – 2Q GDP was revised down to only 1.5% yoy, the slowest growth in 4 years.  At some stage, a slowing economy may begin to cause Britons to reign in their spending.   And consumers know they can save significant money on their weekly food bill.   By being careful and using the German discounters  it is an easy way to save cash.  Even a £100 a week grocery bill adds up to £5200 a year.  Saving £20 a week can free up £1000 in a year – a cheap family holiday. 

The pressure on price from an ever growing Aldi and Lidl continues.  I have done many price comparisons in the past showing how much cheaper both discounters are.  Checking my recent till receipts, the gap may be slightly smaller but still present.  And it always will be because they set up their businesses differently.   British Airways can never compete with Ryanair on price because its costs are structurally higher – its set up differently.  The same with Tesco and Aldi and Lidl.

Dave Lewis undoubtedly has done and continues to do the right things: simplifying the ranges, improving service, cutting and simplifying prices, cutting costs, reduced the store portfolio and capex from the heady boom times.  Although I have yet to be convinced of the Booker deal – the CMA is now expected to rule on that by the end of this month.

So internally he is doing the right things.  But externally the market is extremely tough.  Aldi and Lidl continue to take market share at an alarming rate and their German parents have extremely deep pockets.  And even if many Tesco customers refuse to shop there, the discounters will squeeze down prices across the industry.    

And the wider economic environment is tough – Britons are at record levels of indebtedness with minimal wage growth.  And consumers want to spend their cash in the “experience economy”.

Tesco share price is still below half the peak: 

tesco share price

Looking back over the last few years, it is clear there have been many false dawns – rallies that have petered out. The stock market believes that the high profits and dividends of the past will not return.  Not matter what Dave Lewis does.  Structurally, the profitability of food retailing has fallen for good.  Good news for consumers.. not so good for the industry.

And a 1.6% dividend yield is no reason to hold a share, even when base rates are 0.25%.

One of my all time favourite Buffett quotes is “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”

Apt for Dave Lewis and his team.


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