Having had a weak Christmas for two consecutive years, Tesco (OTCPK:TSCDF) surprised investors last week with a much better than expected increase in like-for-like sales of 1.8 percent in the six weeks to January 5, 2013, driven by strong online sales and a recovery of in-store food sales, showing promising signs that its turn-around plan is starting to work.
Clearly, a far cry from the same period last year, when like-for-like sales had fallen 2.3 percent, triggering the Group's first profit warning in 20 years and a strategic rethink. Also, this was only the second quarter of growth in eight consecutive quarters, and handsomely beat the 1 percent median estimate of 10 analysts compiled by Bloomberg.
Building A Better U.K. Tesco
Nine months into an extensive £1 billion turn-around program, chief executive Philip Clarke warned that there was much more to do:
"We are just nine months into the implementation of our six-part plan, which is about 'Building a Better Tesco' in the U.K. for the long term. Whilst our seasonal performance is encouraging, there is a lot more to do and the team is focused on delivering further improvements for customers in 2013.
"Christmas is one step on the way. It shows with the right plan, the right focus, we can deliver the right performance."
With top-line sales rising 1.8 percent during the Christmas and New Year period, Tesco confirmed for the first time in three years that it had outperformed its U.K. rival J Sainsbury (OTCPK:JSAIY).
However, excluding customers spending loyalty cards coupons, as Sainsbury does, sales at Tesco were up less, though still a commendable 1.4 percent, in comparison to Sainsbury's 0.9 percent for the 14 weeks to January 5th. This was the 32nd successive quarter of sales growth at the company. (Apparently, if Sainsbury had used the same accounting benchmark as Tesco and included sales using points under its Nectar loyalty scheme, its growth figure would have been 1.4 percent. )
It should be noted that, despite the impressive growth, Tesco has not increased its profit guidance for the year. Also, with U.K. consumer price inflation running at 2.7 percent, that still left both retailers with negative real growth.
After years of underinvestment in the U.K. as Tesco chased growth in the U.S. and Asia, Clarke launched a turn-around strategy in April, committing £1bn to revive U.K. sales, investing in more staff, revamping food ranges, refining marketing and smartening up stores to give more space to food. I reported extensively on the initial progress of the program in April, as well as more recently in December.
The fact that Clarke now feels confident enough to step aside as head of the U.K. business with Tesco veteran Chris Bush named as the new managing director suggests that its "Building a Better U.K. Tesco" program is on track. Chris Bush is a 30-year company veteran, currently Tesco's chief operating officer in Britain, who was brought back to the U.K. last year, having led Tesco's Thai business since 2010.
Clarke will step back from day-to-day control of the U.K. business. While remaining close to the British business, his focus would now be on the group's "vision and strategy" (e.g., when to exit the U.S.).
Earlier in the year, Tesco launched its "drive-through" service, available now at over 140 stores, to collect online grocery orders, which helped online food sales to grow 18 percent, while its "click & collect" sales grew 16 percent in the six weeks to January 5th.
While aggressively holding on to its market share, Tesco is clearly ramping up its online presence with the appointment of Robin Terrell as Multi-Channel Director. Terrell is regarded as one of the most influential and experienced leaders in multi-channel retailing in the U.K. He joins from House of Fraser, where he led the multi-channel development, having done the same at John Lewis. He was also COO of Figleaves.com, and for six years, until June 2005, was managing director of the U.K. operations of Amazon (AMZN). Online, Amazon is Tesco's real competitor.
Rest Of The World
Six-week revenue in Asia rose 7.6 percent at constant exchange rates as stronger sales in Thailand offset regulatory restrictions on Sunday trading in South Korea. Revenue in Europe declined 0.6 percent on the same basis. In the U.S., which Tesco has said it expects to exit after announcing a review of its Fresh & Easy chain, sales increased 4.1 percent from a year earlier.
U.K. Grocery Market Remains In Turmoil
Earlier last week, market researcher Kantar Worldpanel said Britain's grocery market grew 3.2 percent in the 12 weeks to December 23, with the strongest growth at the discount and premium ends of the market. Note: Kantar provides data on gross sales, while the focus of retailers' own updates tends to be sales at stores open over a year, or so-called like-for-like sales.
According to Kantar, Tesco saw sales growth of 2.9 percent, but its market share dipped slightly - by 0.1 percentage points to 30.5 percent. Commenting on Tesco's progress, Kantar director Edward Garner said:
"This is an improvement on the performance seen throughout 2012, when the average share drop was 0.4 percent, suggesting that festive shoppers gave the retailer a welcome boost in the run up to Christmas."
In comparison, Sainsbury's saw sales growth of 3.4 percent, edging up its market share by 0.1 percentage points to 17.1 percent, while Walmart (WMT) owned Asda saw sales growth of 2.2 percent, but its market share slipped 0.2 percentage points to 17.3 percent.
In the meantime, Morrisons (OTCPK:MRWSY) posted a disappointing trading update. It was the only "big four" U.K. grocer to lose sales compared to last year -- they fell 0.6 percent, and its market share dipped 0.4 percentage points to 12.0 percent.
On the premium end of the grocery market, Waitrose achieved sales growth of 5.4 percent, while budget chains Aldi, Lidl and Iceland posted respective growth rates of 30.1 percent, 10.8 percent and 9.7 percent, respectively. Commenting on the performance of the discounters, Garner said:
"Historically, the discounter sector has seen its share dip at Christmas as shoppers treat themselves and trade up, but the all-time record share of 3.2 percent for Aldi is a sign of the times and shows that this is no longer the case."
It is clear that many retailers in the U.K. are finding the going tough as consumers, whose spending generates about two thirds of Britain's gross domestic product, fret over job security and suffer the ongoing squeeze on their incomes. With the retail market showing minimal growth, retailers are battling it out to steal market share from each other.
The respective Christmas trading statements of both Sainsbury's and Tesco contained few surprises. Analysts had expected Tesco to rebound from a dire festive period in 2011-12, when it had to issue its first profit warning for decades, while Sainsbury's has seen like-for-like sales grow for 32 consecutive quarters.
While its turn-around is still at its early stages, Tesco's shares are still trading substantially below the levels they were before the profit warning last year, and even somewhat below Warren Buffett's average purchase price of around £3.60. At this stage, investors should be looking at Tesco as a solid 4.4% yield play with some near inflation protection, rather than as a growth stock.
Given the scope for a further re-rating once the U.K. recovery gathers momentum, and with the focus shifting to cash generation, we would expect inflation-beating dividend increases to follow soon thereafter.
Additional disclosure: Our Dividend Income Portfolio owns a shareholding in Tesco Plc, purchased during 2011 and in early 2012, following the trading profits update. At current levels, Tesco is not any longer historically undervalued as per our valuation methodology.