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What’s The Truth About Tesco PLC’s Recovery?

Tesco’s (LSE: TSCO) recovery appears to be getting off the ground. The number of transactions going through the company’s tills is rising, debt is falling, and the effects of cost saving measures should start to filter through this year. 

However, the company’s revenue has continued to contract. Sales from UK stores that have been open at least a year fell 1.1% during the first half, and the group’s net debt remains high, relative to peers. For example, Tesco’s net gearing — net liabilities divided by stockholders’ equity — currently stands at 333%, excluding intangibles. Morrisons and Sainsbury’s net gearing, excluding intangibles, is 23% and 66% respectively. 

So, whilst there  are signs that Tesco’s recovery is starting to take shape, with sales still falling and a mountain of debt to deal with, can the company ever stage a full recovery?

The right direction

It’s clear that Tesco’s recovery will take time. It took larger peer Carrefour more than 24 months to convince the market that it was finally on the road to recovery. 

Nonetheless, even Tesco’s harshest critics can’t deny that the group has made a gargantuan effort to improve trading over the past twelve months. The company is now playing to its strengths. CEO Dave Lewis knows that Tesco can’t realistically compete with the discounters on price. And with this being the case, Mr. Lewis has placed an emphasis on customer service, as well as lower prices. 

This strategy change has had some initial success with the number of transactions at Tesco’s stores rising 1.5% during the first half. Moreover, Tesco is looking to improve its supplier relationships to streamline operations. 

Impressive figures

As Tesco tries to turn itself around, there’s one area in which the company has already made impressive progress — cash generation. 

Many City analysts have been concerned for some time about Tesco’s poor cash generation. For the past two years, the group has struggled to generate any cash at all, relying on debt to fill the gap between cash generated from operations and capital spending. 

During the first half of 2015, Tesco was able to reverse this trend. In the six months to August 29, Tesco generated free cash flow of £281m, compared with a £134m outflow in the same period a year earlier. Many City analysts weren’t expecting Tesco to generate any cash at all. 

With a positive free cash flow, Tesco will be able to start paying off its towering debt pile and reinvest in its operations. What’s more, it is rare for a company with a positive free cash flow to become insolvent. 

What’s the truth? 

Overall, it’s easy to conclude that Tesco’s recovery is taking shape, but investors need to be patient. Tesco is only a year into the most aggressive restructuring the company has ever seen and many changes to the business are only just starting to take hold. 

Still, Tesco’s management seems to have a positive view of the company’s prospects. At the beginning of last month, six of the company’s directors spent £550k buying shares in the troubled retailer.

Up to you 

This is just a rough appraisal of Tesco's prospects. Before making a trading decision, you should conduct your own research to see if the company in question is suitable for your portfolio and financial goals. 

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Rupert Hargreaves owns shares of Tesco. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.