Tesco PLC Profits Collapse As Recovery Plan Kicks Off

Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) fell by 13% when markets opened this morning, after the supermarket issued a surprise profit warning, cutting its full-year trading profit forecast to just £1.4 billion.

That’s a stunning 58% fall on last year’s £3.3bn trading profit, and it’s clear that the final figure could be lower still.

That sounds bad

This is clearly bad news for the firm: Tesco reported a trading profit of £937m during the first half of this year, which was disappointing in itself.

However, today’s announcement implies that trading profit for the second half — which includes the Christmas period — will fall by 50% to around £460m. To put this into context, Tesco’s trading profit during the second half of last year was £1,727m.

My calculations suggest that the Tesco’s earnings per share this year could be around 10p — nearly 40% lower than current market forecasts.

Margins are collapsing

Tesco’s falling profits are being driven by two factors: falling sales and price cuts. Today’s news implies that the firm’s trading profit margin during the second half of this year will be less than 1.5%.

To put this into context, Tesco reported a trading margin of 5.2% last year, and of 3.0% during the first half of this year.

What about those dodgy accounts?

Tesco said today that its “entire [management] team” has now been “retrained” and the company is now working with its suppliers to implement a “new Commercial approach”.

This is good, but the fact it is necessary suggests to me that the commercial income problems were quite firmly embedded in Tesco’s operating procedures, and were not just the isolated actions of a few individuals.

What about the dividend?

In my view, today’s news puts Tesco’s final dividend payment in doubt. Current consensus forecasts suggest a final payment of around 3.2p, bring the total for the year to 4.3p.

However, I expect analysts’ estimates to be downgraded again following today’s warning.

Will Tesco need to raise cash?

We won’t learn more until at least 8 January, when Tesco’s Christmas trading statement is due, and Tesco has promised investors more information on “the measures we plan to take  …  to strengthen the balance sheet”.

These measures could include selling off the firm’s European or Asian operations, and potentially a rights issue. Until we know more, I expect Tesco shares to remain weak.

Indeed, although I remain a Tesco shareholder, I rate the shares as a fairly risky purchase at present, due to the uncertainty surrounding the firm's turnaround plans.

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Roland Head owns shares in Tesco. The Motley Fool UK owns shares of Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.