Is Tesco plc on track to meet its ambitious profit targets?

Should you buy Tesco plc (LON:TSCO) and Capita plc (LON:CPI) as turnaround plays?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Tesco (LSE: TSCO) recently announced that hourly pay rates for its store staff will rise by 10.5% over the next two years. Rising wages sound like good news for the supermarket’s employees, but what about for its shareholders?

Inflation

To some extent, growing wage costs are to be expected. Although wage growth in the UK has been sluggish in recent years, inflation has been growing at a steady pace and rival supermarkets have announced similar pay rises. As such, Tesco needs to do more to attract (and keep) the talent it needs to stay competitive. And what’s more, despite the proposed pay increases, its staff will still be paid less that those at Aldi and Lidl, its two German low-cost (but higher-pay) rivals.

Nevertheless, wages are one of the largest single expenses for Tesco, with the total employee pay bill totalling £7.4bn last year. That’s equivalent to almost six times the group’s annual operating profit, which means even a modest increase in pay would be a serious drag on margins and profits.

Margins

By 2019/20, Tesco expects to deliver group operating margins of 3.5% to 4%. That’s almost double today’s margin of around 2%, but still significantly below the 6.5% it enjoyed in its glory days.

To lift its margins, the company has undertaken big steps to simplify its product range and improve its store operating model to increase customer satisfaction while also cutting costs. The supermarket giant has conducted a thorough review of its entire cost base and has plans to remove another £1.5bn from its annual operating cost base. But is the company still on track to meet its ambitious profit targets?

I reckon it’s too early to say as the group has recently shown some mixed results. Although it reported its strongest quarterly like-for-like sales growth in the UK, international sales have weakened dramatically. In addition, City analysts are divided over whether Tesco can keep a lid on costs as inflation rises and as real household incomes come under pressure.

Capita

Tesco is not the only company looking to turn its profits around. Outsourcing outfit Capita (LSE: CPI) is similarly looking to bounce back from tough times.

The company announced a series of profit warnings last year as clients delayed making big investment decisions amid the Brexit uncertainty. As a result, underlying pre-tax profits for 2016 fell by 19% to £589m.

Lately though, things appear to be turning a corner as the business process manager is seeing activity in the private sector return to good levels and has secured multiple contract wins. 

Capita’s balance sheet is also set improve as it recently announced the sale of its asset management services arm to Australian firm Link Administration Holdings, which would net the outsourcing firm £888m. This would help to ease its debt position, which currently stands at just over £1.7bn.

As such, I have more confidence that Capita will be able to maintain its dividends at current levels. And although its shares have recovered in value by 34% since the start of the year, I reckon they still represent reasonable value, with Capita trading at just 13.5 times expected earnings this year and yielding 4.6%.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jack Tang has a position in Capita plc. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Concept of two young professional men looking at a screen in a technological data centre
Investing Articles

Investing £5,000 in a Nasdaq 100 index fund 5 years ago would be worth this much now

Zaven Boyrazian looks at the Nasdaq 100 index’s performance since December 2019. Has investing in an index fund been good?

Read more »

Electric cars charging at a charging station
Investing Articles

Why the Tesla share price rocketed 38% in November

Our writer considers the reasons for the recent red-hot Tesla share price performance. Is now a good time for him…

Read more »

Frustrated young white male looking disconsolate while sat on his sofa holding a beer
US Stock

Why NIO stock fell 13% in November

Jon Smith flags up a couple of key factors that he believes contributed to the fall in NIO stock over…

Read more »

Investing Articles

Which of these UK stocks is the better bargain in December?

Stephen Wright thinks Diageo and Senior are very different UK stocks with very similar prospects. But which one offers better…

Read more »

Frustrated young white male looking disconsolate while sat on his sofa holding a beer
Investing Articles

Mistakes to avoid when investing in the FTSE 100!

The FTSE 100 offers great near-term valuations and dividend yields, but Dr James Fox believes investors should be wary when…

Read more »

Investing Articles

Here’s why the Scottish Mortgage share price jumped 9.2% in November

The Scottish Mortgage share price has been outperforming indexes over recent weeks. Ben McPoland digs into some reasons why.

Read more »

Investing For Beginners

Why the IAG share price rocketed 24% in November

Jon Smith explains why the IAG share price did so well last month, citing three factors at work that helped…

Read more »

pensive bearded business man sitting on chair looking out of the window
Investing Articles

I think Tesla stock’s overpriced. So why not short it?

Our author thinks Tesla stock has got ahead of itself since the US election. So why not put his money…

Read more »