Tesco (TSCO) the biggest supermarket in the UK by market share with 26.7% of the pie, has announced its half year results for the 26 week period ended 27 August 2022.
To put their market dominance in context, they are almost twice as big as it's next competitor, Sainsbury's, who have 14.6% of the market. Therefore when Tesco release any financial results they are probably worth reading as they could be regarded as a barometer for the wider economy.
Essentially, if the general public are going through a cost of living squeeze, this should be reflected in this supermarket's results.
What Do The Results Show?
On first glance, looking at the top line, everything seems to be going ok, with total revenue for the 6 months to 27 August increased by 3.1% to £28.178 billion.
However if you look at the bottom line you'll notice that their pre-tax profit dropped by 63.9% to £413m.
The reason for this is that Tesco's margins are being squeezed, for two reasons.
Rising Energy Costs
Even though their food sales grew by +1.6% in the half, their cost of sales rose by 9.81% from £27.9 billion by £30.6 billion, meaning their gross profit decreased by -30%.
Cost of sales is how much it costs to create and sell a product and this increased due to commodity price inflation and supply chain issues.
The result of these issues means the cost of selling their staple products, specifically within their bakery, dairy and grocery divisions, increased.
If a company has little competition then these price rises can be passed into the consumer but the UK supermarket sector is highly competitive.
Increasing Competition
Tesco faces fierce competition particularly from the so called discounters, Lidl and specifically Aldi who have just increased their market share to take the 4th position from Morrisons.
Just glancing at Tesco's release suggests they are taking the threat of Aldi's inexorable growth seriously, who they mention 8 times in regards to their Aldi Price Match strategy.
This means, if Tesco want to stay competitive, against their competitors, they are limited in how much they can raise prices for fear that their customers will go elsewhere.
Margin Squeeze
So in summary inflation has increased their input costs and competitors limit Tesco passing these prices increases on, especially when consumers are being squeezed by the cost of living pressures themselves.
In the mid term, commodity prices are expected to moderate, which will help Tesco's margins but how long with this take? The worry is that shoppers who have already changed their shopping routines to include visits to the discounters, will need a big incentive to be a Tesco only shopper.
Tesco say their strategic priorities are to, "support customers by offering great value, quality and convenience, and rewarding loyalty" but will this be enough to stop Aldi's relentless gab on their market share?
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Patient Investors hold for the Divi
As for investors Tesco maintained their profit guidance within their previous range, albeit towards the lower end suggesting, "adjusted operating profit of between £2.4bn and £2.5bn".
They also stated that, "Significant uncertainties in the external environment still exist, most notably how consumer behaviour continues to evolve".
However they say their, "Ongoing focus on cash and a more positive expectation on working capital leads to an upgrade in our expectation for full year retail free cash flow to be at least £1.8bn".
This cash generation is good news for investors who hold for dividends, which has also been increased by 20% from 3.20p to 3.85p a share.
However the market seems to want more re-assurance than larger dividend pay-outs as Tesco's share price dropped 3% to 203p after releasing their interim results.
Also when you consider that this is on the back of their shares being down -30% since the start of the year, Tesco are certainly living up to their, "Low Everyday Prices" in this respect.