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Why is the Tesco share price falling?

Image source: Tesco

FTSE 100 supermarket giant Tesco (LSE: TSCO) reported strong sales numbers this morning, but investors are not impressed. The Tesco share price is down over 2% as I write. 

I think there are at least two possible explanations for this in the earnings update itself. 

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#1. Can it sustain high sales growth?

One of the opening statements in the Tesco earnings’ release is “sales exceptionally strong, growing UK market share in the year and gaining customers from all key competitors”. Its sales increased 7.1% for the full year ending February 27.

The UK and Ireland, which contribute over 90% of its total revenues, grew by 8.8%. Even more impressive than the overall sales growth was the online sales increase of 77%. This is a confidence-booster for a potential investor like me. 

However, the company attributed some of these additional sales volumes to Covid-19 restrictions. These are likely to “fall off”. In other words, we can expect Tesco’s sales growth to slow down in the coming months. This may have encouraged investors to steer clear of the stock so far.

#2. Profits slow down, dividends are static

While sales are expected to slow down, Tesco’s profits and free cash flow had already declined last year. Its operating profits were down by 28% and cash flow fell by 30%. It expects both to recover over time however, as Covid-19 related additional costs become a thing of the past. 

With shrinking profits, it is hardly surprising the supermarket has kept dividends unchanged at 9.15p. It still has a dividend yield of 5.3% though, which is higher than most other FTSE 100 stocks today.

Nevertheless, this could have disappointed investors. Other FTSE 100 companies, like banks, have resumed dividends in anticipation of a better year recently. And Tesco does expect a better year ahead.

Competitive market for Tesco

Tesco also operates in a challenging market. It has many competitors and bricks-and-mortar retailers are increasingly struggling to stay relevant in a world where sales are increasingly moving online. 

I like that Tesco geared itself up for online sales. As a regular user of its app for my grocery deliveries, I have first-hand experience of both the choice and convenience it brings. But online sales for the UK are still relatively small at 16% of the country’s total sales. 

The bright side for the Tesco share price

Still, I think the online business can continue to grow, helping Tesco transition into the future. With a better bottom line going forward, it could be in a better place to increase dividends in the future as well. It already has a high yield, and if the Tesco share price stays at around the current levels, higher dividends can place it among the best dividend-payers across FTSE 100 stocks.

The verdict

But these are possibilities for the future, which may or may not play out. Moreover, the Tesco share price has underwhelmed in recent years. I would like to see how the post-Covid-19 scenario develops before buying the stock. 

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Manika Premsingh has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. 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.

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