Tesco third quarter sales fall: What the analysts say

Tesco has revealed what, by its own history and standards, is a disappointing and poor trading statement for the company. Against far from compelling comparatives across much of the group, but particularly Europe and the UK, Tesco has not managed to break the constraint of subdued revenue growth. That said, we are relieved that full year expectations as guided by the company remain intact, an expectation that may be the focus of attention in questions for management as to how this can be achieved. Whilst testing for both Tesco shareholders and ourselves we still support the strategy, encourage management to keep focused upon improving the performance of its existing store estate whilst constraining capital expenditure on new stores and building out its online and digital capability. Accordingly, whilst we do not hide our disappointment that Tesco cannot yet engineer a better trading performance than recorded in Q3, we believe that its strategy, valuation, yield and the promise of the benefit of economic recovery in the UK and Europe still make for a BUY recommendation. Shore Capital analyst Clive Black

It is worth noting that only 1 out of the last 12 trading updates has posted a positive LFL. Management comments about ‘the UK consumer responding positively to the changes being made’ seems hollow if Tesco is not outperforming the market or being able to differentiate itself from the competition. Furthermore, management continue to point to general merchandise as a reason for the UK trading margins remaining stable at 5.2%. We find this hard to believe given non-food is in a gradual transition/de-listing and has a low sell-rate. We also believe that total operating costs must be growing at c.3% given new space costs, higher energy, business rates and rents which cannot be covered by limited sales growth and gross margin. The overall Q3 update seems to duck most of the key issues around; UK margins, Price promise, new fresh layouts, Finest launch etc. If these are working, should we not expect them to support Tesco’s UK outperformance rather than the in-line one we have today? Cantor Fitzgerald analyst Mike Dennis

Ongoing flaccidity in Tesco’s like-for-like sales occurs against the backdrop of significant investments being ploughed into store remodels, multichannel and revamped private label lines. This is placing pressure on Tesco’s treasured 5.2% operating margin, calling into question the wisdom of protecting margin while the business is struggling to keep pace with a strong competitive set in a sluggish UK market. This situation has seen some observers call for Tesco to adopt the much-vaunted ‘nuclear’ option on pricing, an investment of margin into an aggressive price repositioning that would theoretically plunge price-matching rivals into turmoil, slashing their cash flow and profits. While this is certainly one option, we believe that the recent past shows us that value is so much more than price. While the disruptive nature of severe price investment might be tempting, our view would be that further investment in innovation, in-store experience, quality and service is the correct course of action in order to lay the foundations for sustainable long-term recovery.   Kantar Retail’s Director of RetailInsights Bryan Roberts  

Ahead of the Q3 sales update from Tesco today, the market had been softened up for bad news, with -1.5% LFL for the UK widely expected, but there is no major new news today and no profit warning. With every single region down LFL it is not immediately apparent how Tesco have limited the bottom-line damage, but they point to improved performance in Poland and Turkey and seem confident in the strategy. Needless to say, CEO Phil Clarke does not meekly agree with the view that it should demolish its 5.2% UK operating margin target and launch a price war and states that “We are confident that our strategic priorities - strengthening the UK business, establishing multichannel leadership and ensuring capital discipline - are the right ones and that they will drive long-term value and returns”. No doubt he will be challenged on the 8am conference call with analysts, but the shares should rally first thing. Independent analyst Nick Bubb