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Tesco Plc; Updating Price Target and Trading Guidance – 04 September 2014


Company and Market Overview:

Tesco Plc is a grocery retailer that is headquartered in the UK. With more than 3,000 stores, employing 500,000 people worldwide, Tesco has grown to become one of the world’s largest supermarket chains since it was established in 1947. The group is a FTSE 100 company, listed under the general retailers segment of the London Stock Exchange.

The UK grocery market is subject to fierce competition and currently dominated by the “Big Four” supermarket chains, Tesco, Sainsbury’s, Asda, and WM Morrison. These firms occupy what is frequently referred to as the middle segment of the market, while continental discounters hold the lower tier and the home grown, quality-focused Waitrose and Marks & Spencer attract the more affluent customers at the higher end of the income spectrum.

Index FTSE 100 Ticker TSCO.L Latest Close 230.00
52 Week High 381.00 52 Week Low 224.00 P/E 7.2
Dividend Yield % -TBC-?? Dividend Cover CEO: David Lewis
CFO: Alan Stewart Price Target 175.00

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Trading update – dividend cut drives shares lower

Following the announcement that the group was replacing its Chief Executive some weeks ago, Tesco Plc shares have fallen substantially, hitting our price target, and then declining further to a new decade-long low.

A key catalyst of the additional leg downwards has been a 75% cut to the dividend and the group’s second profit warning within two months. While the reduced dividend comes as a surprise, we do see the logic behind management’s actions.

In addition to the dividend cut, Tesco announced that capital expenditure at the group would be cut dramatically during the year ahead, mostly through a mixture of restructuring and by slowing down the pace of its £1 billion store renovation programme.

The new Chief Executive, Dave Lewis, has also been called forward to start in his role a month ahead of schedule and will be undertaking a full review of all operations in order to assess the potential for further savings and strategy changes.

Tesco at Hourly Intervals

TescoHourly5SEPT

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We remain bearish on Tesco over the near – medium term and consequently, revise our price target lower to 175.00 pence

We wrote previously about how we view the problems of Tesco. Since this time, little has changed, and we reiterate that both earnings and market share are likely to suffer further over the near to medium term.

The group is still subject to an exodus of customers, who have defected to both rival supermarkets, as well as the discounters. We believe that there are two key drivers behind this decline. The first of these is a lack of competitiveness on prices in the face of a growing discounter presence in the UK.

The second important driver has been a perceived decline in product quality and standards, which adds insult to injury, particularly in the aftermath of the horse meat scandal of 2013.  

Consequently, price competition alone is unlikely to prove sufficient enough to win back UK households who have ventured onto the other side of the street.

We believe that the road back toward being a preferred destination for shoppers will require a substantial overhaul of the group’s own brand products and a significant emphasis on the importance of quality in the group’s communication with customers. This is in addition to the overhaul of its pricing strategy.

Should a restructured and refocused management team opt for such a strategy, then Tesco could someday become an attractive turnaround play. However, even if management does proceed in this direction, results will not happen overnight and when they do it will most likely have been at a further cost to the group’s margins.

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Takeaway

In short, we continue to see downside risks to both earnings, as well as the share price. While we believe there is scope for the group to become an attractive turnaround play over time, Tesco’s margins and earnings will need to re-base first.

In relation to price targets, we see negative sentiment and performance risks driving the shares lower throughout the months ahead.

Consequently, we expect any recovery to be both temporary and limited, with gains capped at 265.00 pence. This is while our price target, updated today, implies a further leg downwards to the 175.00 pence level.

The next major event scheduled in the calendar for Tesco Plc is the release of Interim Results on 01 October. Accordingly, we shall review both financial performance as well as the shares in greater detail at this time.

 

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