Sales Rise As Tesco PLC Returns To Profit

The Tesco (LSE: TSCO) turnaround is now firmly under way. Like-for-like sales rose by 1.6% during the fourth quarter, delivering the first quarterly gain in three years. Tesco has also returned to profit after last year’s £6.4bn loss, with a £162m pre-tax profit.

However, these figures don’t reflect all of the progress made by ‘Drastic’ Dave Lewis in his first year as chief executive. A closer look is required.

Sales rise despite falling prices

Supermarkets’ headline sales figures refer to the total value of goods sold. They don’t tell you whether the number of items being sold is increasing, nor whether transaction numbers are rising.

Tesco’s UK like-for-like sales only rose by 0.9% during the fourth quarter, but this was against a backdrop of falling prices. The firm says that UK volumes rose by 3.3% during the fourth quarter, while transaction numbers rose by 2.8%. These numbers suggest to me that Tesco is having some success in defending its market share.

Debt slashed

Tesco’s net debt fell from £8.5bn to £5.1bn last year. That’s an impressive 40% reduction. Fears that the company will have to raise fresh cash from shareholders are now likely to fade away.

In my view this is one of Mr Lewis’s biggest achievements. By selling the firm’s Korean business and making a number of other cuts and disposals, he’s put Tesco on a much stronger financial footing. Tesco’s interest payments fell from £613m to £426m last year, freeing up nearly £200m of cash flow.

Tesco is also aiming to reduce future lease payments by buying back the freehold of its stores where possible. The portion of the group’s UK and Irish property which is freehold rose by 6% to 47% last year, as it regained ownership of 70 stores and two distribution centres.

Improved profitability

Tesco closed 60 lossmaking stores last year. The number of products sold was cut by 18%, while head office headcount was reduced by 25%. These changes helped to push Tesco’s adjusted operating profit up by 1.1% to £944m last year. This increased the group’s operating margin that rose from 1.65% to 1.73%.

Although this seems low, profit margins are expected continue rising this year. It will take another 6-12 months for the full benefit of last year’s cost savings to filter through to the bottom line.

Is Tesco a buy?

Tesco shares fell by 3% to 190p when the market opened this morning. Although Dave Lewis has scored some big wins this year, most of this good news was already in the price.

There was no mention of a dividend in today’s results and Tesco says it will be “continuing to invest in our customer offer” this year. That’s retail code for cutting prices, which suggests to me that Mr Lewis will continue to focus on increasing Tesco’s market share. Dividends may have to wait.

Broker forecasts suggest that Tesco’s earnings will rise by 88% to 8.7p per share this year. A token 1.5p dividend is also expected. However, with the shares at 190p, this gives a forecast P/E of 22 and a yield of 0.8%.

I expect profits to continue to recover over the next few years, but I’m not sure Tesco shares offer much value at their current price.

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Roland Head 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.