Supermarket giant Tesco (LSE: TSCO) has a market-leading position when it comes to grocery sales in the UK. But owning Tesco shares means more than just owning a stake in a British supermarket chain. It has been slimming down its international footprint, but still has some operations overseas. On top of that, Tesco also offers banking services.
The Tesco Bank business announced today (9 February) it plans to sell its existing credit cards, loans and savings to Barclays. This is expected to mean Tesco receiving around £1bn totally in cash (of which, a quarter was already received as a special dividend last summer).
Banking on it?
The logic for supermarkets running their own banks once seemed obvious. They had large customer bases visiting their stores or websites regularly. From customers’ shopping history, a grocer could likely make some educated guesses about them. Meanwhile, supermarkets have familiar brands that regular customers often trust.
In practice, things have been more mixed. Banking revenues of £700m in the company’s first half are a drop in Tesco’s ocean of sales that totalled £34bn. But banking can be much more profitable than flogging baked beans. In the first half, the bank’s percentage profit margin was 9.3%, more than twice the 4.4% achieved in its retail division.
Sainsbury’s sold its mortgage book last year and has said it is open to selling its remaining banking operations. Tesco has also started to reduce its banking footprint with the Barclays deal.
For now though, it plans to retain “capital-light, profitable businesses with a strong connection to our core retail offer”, such as insurance, cash machines, travel money and gift cards.
Still, it seems the initial strategic idea of supermarkets running banks is losing ground in the UK. So what might this mean for Tesco shares?
Possible impact on the price
The company said that the majority of the cash raised by the sale would be “returned to shareholders in the form of an incremental share buyback”.
I quibble with that use of language. A special dividend (such as the company paid when it spun off its Asian operations several years ago) is returning cash to shareholders. A buyback does not directly do that, it simply returns cash to some investors who sell their Tesco shares to the company in the buyback.
The theory is that it pushes up the price, but in practice, that does not always happen.
Tesco shares have risen 17% in the past year, so buying them back now would be less of a good deal for the supermarket than when they were cheaper. Every little helps, after all.
Tesco said it expects the deal and buyback to lead to “mildly” higher earnings per share. That could help boost the share valuation slightly, although it may not.
I think exiting parts of the banking business could help focus management’s attention on core retail operations. That could be good for the business over time. I continue to like its strong brand, economies of scale and large customer base.
For now however, I do not find Tesco shares to be especially attractively priced given the relentless competitive pressures supermarkets face. I have no plans to buy.
