Tesco’s shares have fallen more than 15% so far this year, with investors concerned that rising food prices could drive shoppers towards the supermarket’s cheaper rivals.
Inflation is weighing on sentiment in other ways, too, as wage increases and soaring fuel prices add to Tesco’s operating costs, squeezing its already ultra-tight profit margins.
As the UK’s largest supermarket chain by market share prepares to announce its Q1 results on Friday, we look at how the business is performing and assess whether its shares can regain lost ground.
Inflationary pressures
With UK inflation running at 9% and set to climb even higher, investors appear anxious over the impact of rising prices on Tesco’s business. One fear is that, if the retailer passes higher production and wholesale prices on to its customers, some shoppers may turn to more affordable competitors such as Aldi and Lidl.
At the same time, Tesco has increased wages by 6% in an effort to retain staff. Hiring conditions remain tough for employers. According to the Office for National Statistics, in January to March the number of job vacancies was larger than the number of unemployed people for the first time on record.
Furthermore, skyrocketing fuel prices are pushing up transportation costs, raising the cost of deliveries to stores and customers’ homes.
These pressures are likely to have contributed to higher operating costs in Q1, and are unlikely to ease in the near term. The result will be a squeeze on Tesco’s thin profit margins of 2-3%.
While cost-saving measures may go some way towards offsetting these pressures – Tesco is in the midst of a three-year cost-cutting programme that it hopes will generate savings of £1bn – further savings may be needed.
Outlook warning
Although Tesco posted solid full-year results in April, with group operating profits up 58% year-on-year at £2.83bn, the company also guided that profits in the current financial year are set to fall slightly – another factor that has dented the share price.
The anticipated drop in profits comes despite Tesco having increased its share of the UK grocery market to 27.4% as of mid-May, according to data from Kantar. Tesco attributes this growth in part to its Clubcard scheme, which has more than 20m members. Cardholders pay lower prices on selected items, helping foster brand loyalty.
As well as expanding this scheme, Tesco plans to broaden its Aldi price-match scheme to include 650 lines. Both measures should support efforts to retain customers as Tesco battles its rivals on prices. The intense supermarket price war has even seen upmarket chain Waitrose enter the fray, with the John Lewis-owned brand launching its first ever value range ad campaign in April.
Focus on guidance
Given the effect that inflation is having on food prices, wages and fuel costs, it is perhaps understandable that investors are approaching Tesco shares with caution. The outlook will certainly need to improve significantly if Tesco’s shares are to make up the ground they have lost this year.
Beyond the headline sales and profit numbers, investors will again be paying close attention to guidance when the company releases its Q1 trading statement at 7am on Friday 17 June.
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