The latest interim results from Tesco (LSE: TSCO) were one of the investment highlights of last week.
What emerged, in my view, was evidence that a slow but steady turnaround is now underway.
Here are three reasons why I believe now could be a good time to buy.
1. Customers are coming back
One of Tesco’s biggest problems has been the loss of market share it has suffered to other supermarkets, including discounters Aldi and Lidl.
Last week’s results suggest Tesco is starting to win back some of this lost business. The number of transactions in UK stores rose by 1.5% during the first half, while the volume of items sold rose by 1.4%.
Although like-for-like sales fell by 1.1% in the UK, this reflects the impact of lower prices, not falling sales.
Tesco is winning back some of its lost market share.
2. A long-term view
‘Drastic’ Dave Lewis, Tesco’s chief executive, appears to be taking a long-term and sustainable approach to turning around the business.
Tesco has made public a set of improved and simplified payment terms for suppliers. Promotional pricing has been reduced and prices of staple items reduced. Changes to shelf-edge labels — a common source of price confusion for customers — have been reduced by 21%.
On a business level, product ranges have been reviewed and simplified. A total of 53 loss-making stores have been closed, and the firm has agreed to sell its Korean business for £4.24bn. This will reduce Tesco’s net debt by £4.2bn. It’s also decided to keep hold of its Dunnhumby marketing business rather than sell it too cheaply.
All of these changes should improve customer appeal and improve Tesco’s reputation, which took a battering as a result of the profit misstatement scandal. Mr Lewis appears to be targeting a long-term win, rather than scraping the barrel for a short-term profit boost.
Despite this long-term approach, Tesco is still making money and reported an operating profit of £354m. This was backed by net cash generation from retail operations of £779m and retail free cash flow of £281m. That’s not bad in the circumstances.
3. Banking a profit
You could argue that banking is not a core activity for a supermarket. Yet the latest results from Tesco Bank suggests that this combination is working very well.
Tesco Bank contributed £86m, or 24%, of the group’s operating profit during the first half of the year.
Better still, the bank’s operating margin was a generous 18%. Although this was down from 20.5% last year, this is mainly due to a regulatory change in credit card income.
Lending to customers rose and the bank’s net interest margin was 4.2%. That’s roughly double most of the big high street banks.
My view is that Tesco Bank appears to be generally competitive and a successful add-on to Tesco’s retail business.
Still some concerns
Despite my positive view on Tesco, I do have some concerns.
Net debt is £8.6bn and total indebtedness, including pension liability and lease commitments, is £21.9bn. The sale of the Korean business will reduce this by £4.2bn, but a rights issue to raise fresh cash remains a possibility.
Significantly, whereas Mr Lewis has ruled out further asset sales, he has not ruled out a possible rights issue.
