EUR 850.00 For Business Accounts Only

Morningstar | Tesco's Preliminary Results Reveal EBIT Beat, International Markets Ahead; Shares Fairly Valued

Tesco's 2019 preliminary results have U.K. and Ireland like-for-like sales up 2.9% (core U.K. up 1.7% like for like and Booker up 11.1%). Group EBIT growth, including Booker, was up 35% to GBP 2.21 billion. This is almost 9% higher than our full-year estimates due to better profitability in the international segment, faster Booker synergies (EUR 79 million versus EUR 60 million in our model) and cost savings delivery (GBP 532 million versus GBP 450 million in our model). Management reiterated guidance on synergies and medium-term margin targets and raised the dividend at GBX 5.77 per share, 15% higher than our expectations. Given this better-than-expected print, we expect to raise our GBX 253 fair value estimate by a mid- to high-single-digit percentage to reflect the time value of money (3%) and better-than-expected underlying profitability (3%-4%) in the international business. Given that midterm guidance was unchanged, we estimate around 4%-5% of the 9% EBIT surprise versus our estimates was due to faster delivery of Booker synergies and cost savings, thus it won't affect our fair value estimate.

Although like-for-like performance in the core U.K. market was not eye-popping (up 1.7% versus 2.2% in our model), it was better than Morrison's 1.5% and Asda's 1% in the fourth quarter. Profitability-wise, this year's U.K. and return on investment operating income include a benefit of GBP 52 million relating to a change in Clubcard accounting estimates and no losses from Tesco Direct (estimated at GBP 94 million in fiscal 2018), which was closed back in July 2018. We note that if we exclude the faster delivery of synergies and cost savings along with the unanticipated Clubcard accounting benefit, the final EBIT surprise was much smaller at around 1.3% versus our estimates.

We believe Tesco is the best-positioned big four grocer in the U.K., given its channel exposure, scale, and high quality exposure in the dynamic wholesale market through Booker.

The latter continues to grow rapidly, with 11.1% like-for-like growth during the year. We expect lower but still-high like-for-like growth for Booker (4.5% average annual growth rate over 2020-23) driven by management's GBP 2.5 billion growth aspiration.

In Asia and Central Europe, top-line growth was broadly in line with our forecasts, but profitability was 34% ahead of our estimates, driven by cost reductions, profit mix (Europe) and supplier negotiations concluding (Asia). In Poland, Tesco closed 62 lossmaking stores (from 14 stores in the third quarter), evidence of the aggressive approach the grocer is taking to stem profitability issues in the region.

The company announced that its capital market day will take place on June 18, when management will share some of Tesco's "untapped value opportunities."