The Motely Fool Financial Publication Looks at Today's Sales and Profit Report From Tesco PLC

Tesco Toughs It Out
By David Stevenson 15 April 2008

How has Britain's biggest retailer been faring recently?

Today's preliminary figures from the titanic Tesco (LSE: TSCO) were always going to be a bellwether of consumer spending.

And for all those who find the grocer's increasing domination of the UK retail scene rather unnerving, the results make disconcerting reading. Because Tesco has, yet again, produced strong results and an upbeat statement to quell the doubters.

Britain's biggest supermarket unveiled a better-than-expected 12% bounce in net income to £2.1bn for the 12 months ended 23 February, equivalent to 26.61p per share. Sales improved more than 11% to almost £52bn and the full year payout was hiked 13% to 10.9p per share.

But it wasn't all plain sailing.

That profit growth was still Tesco's lowest in the last eight years, and there were more slowdown signs in the second-half, where net income only nudged up 8% against last year to £1.19bn.

What's more, rumours had been circulating that progress at the retailer's much vaunted American venture, Fresh & Easy, had been proved than perfect. The convenience store chain which focuses on low-priced fresh food was launched in California five months ago, but expansion plans were put on hold in March.

Analysts had been suggesting that the 60 store US business was performing well below initial forecasts. Tesco gave no sales breakdown, though turnover is "ahead of budget", with revenue of more than $20 per square foot in the best performing stores, better than local rivals.

But there was no contribution to profits, as Fresh & Easy made a £62m trading loss last year. Tesco expects the deficit will climb to £100m in the current 12 months before declining when sales momentum builds up, and confirmed that it aims to open 150 stores this year, as well as a second distribution centre in northern California.

The international business did well overall, with revenue increasing more than 25% to £13.8bn and contributing over 50% of the growth in both group sales and group trading profit. Underlying profit margins improved too, despite first-time consolidation of the Chinese unit where Tesco's shareholding has reached 90%.

Where now?

Back in Britain, all eyes were on the statement about future prospects. £1 out of every £8 spent in the UK passes through Tesco's tills, which absorb about £1 in every £3 spent on grocery shopping.

With a UK supermarket share of 31%, almost the same as rivals Asda and Sainsbury (LSE: SBRY) combined, Tesco has become a barometer of consumer confidence. So a continuation of January's caution would have sounded another loud warning bell about consumer wellbeing.

No need to worry...well, for the moment, anyway.

Earnings enjoyed a "strong start" in the current year, according to the company, with UK same-store sales excluding fuel advancing 4% in the first five weeks, compared with a 3.5% gain a year ago. Total turnover jumped 13%. What's more, plans to raise £5bn through property sales are still on track.

Although 2008 will still be a "tougher year" for UK shoppers, the company said its expense reduction programme has already enabled price cuts on more than 12,500 products in Britain in 2008's first three months.

Yet despite the fine figures, Tesco has good reason to be concerned about future retail trends. Repeating its earlier call for further Bank of England interest rate reductions, the company will be well aware that the latest indications on both consumer confidence and the housing market do not bode well for spending in its stores in the second half of the year.

Particularly as food costs continue to climb.

In essence, I don't believe that Tesco can prove immune to the economic slowdown. Nor does the stock market, which has chopped the share price by almost 12% since the end of 2007, equating to a 4% undershoot of the FTSE 100 index.

On a prospective price to earnings ratio (PER) of some 15 times current year net profits, with a sub-3% yield, Tesco still isn't that cheap. In my book, still worth holding, but not yet a ‘buy'.

Fresh & Easy Buzz Editor's Note: Read our analysis of Fresh & Easy USA based on today's Tesco PLC's annual sales and profit report here. (Just scroll down to the second story.)