Although Tesco's revenues look fine, a closer look at their accounts reveals something more worrying. Bengt Saelensminde examines the reports and asks whether the supermarket can turn its fortunes around.
On Wednesday, we took a look at a great shortcut you can use to get to grips with complicated company accounts. I kicked the ball off by looking at Tesco's accounts. And we saw how Tesco shares have been through the wringer of late.
After twenty years of pretty solid performance, the latest set of accounts show a chink in the armour.And many investors are concerned.
What's gone wrong?
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The five-year summary threw up some serious issues for Tesco. Though revenues looked fine, margins are falling, its stores are too big and to top it all, they've lost a load of money on payment protection insurance(PPI) misselling at Tesco bank.
The question is, can Tesco turn things around? That's what I want to talk about today
Where did all that cash go?
After a perusal of the five-year summary, I usually head straight for the cash-flow statement. Unlike the P&L account (profit & loss), there's no room for management interpretation on these figures.
This statement tells you exactly how much cash came in, and where it went. You can find it on page 23 of the preliminary accounts to download a copy just click here.
During 2012 the business generated £4.4bn after tax and interest (up about 5% on last year). Now, bearing in mind the company only paid shareholders £1.2bn as a dividend that leaves over £3bn sloshing about!
Where did it go?
Continuing down the cash-flow statement, you'll see that practically the whole lot went on "investing activities." After all their investments in stores, plant, machinery are netted off with sales (of stores etc), the firm managed to spend a full £3.2bn. Last year it was only £1.9bn! That's quite a change.
This is the big issue we picked up on in Wednesday's Right Side. Basically Tesco has been shelling out on big stores. Its average store size is going up and up.
Many of these projects must have been committed to years ago. And unfortunately these big stores haven't been good for business. The megastores are heavily geared towards non-food items... precisely the stuff that's migrating towards the internet.
And as we continue down the cash-flow statement, we see the ramifications of this massive investment activity. Under the heading "Financing activities" we see that last year Tesco wasn't able to pay back any debt. All the cash was absorbed in this investment spree. A far cry from last year's near £2bn pay-down of borrowings.
This has rightly got investors spooked. I'll come back to this issue in a moment...
But just before we leave the cash-flow statement, let me draw your attention to one more thing. Last year Tesco spent a whopping £303m buying back its own shares (compared to just £31m the year before).
I've always said I don't like share buy-backs. Management always seem to shell out big money on buy backs right at the top of the market. And this seems to be a classic example of just that.
It'll be interesting to see if management continues to buy back their shares now that they're cheap... but I tell you; I bet they don't!
Which way will Tesco go?
The good news about a business that's got itself into a dangerous spending habit is that it can kick that habit. And once it does, then there's a load of cash that comes straight back in through the doors.
The management team have clearly recognised past errors. This year they're scaling back on big-store developments, instead focusing their attention on the more effective small express stores. And that's going to be great for cash flow.
Looking at the figures in the cashflow statement, Tesco could practically triple the dividend if they simply stopped investing.
But of course, Tesco is hardly likely to wield the hatchet that aggressively. It would hardly be good for future growth. But so long as there are cutbacks, and management invest in the right places, then I see grounds for optimism.
Tesco's six-point plan looks good
As I said on Wednesday, I don't care too much for management spiel and platitudes plastered all over the report and accounts. I tend to ignore them.
But for Tesco's, this year is a little different. So I've given their report a bit more attention than usual. Seeing as there's a new management team that seems committed to making some big changes, I've listened to whatit's got to say.I've even trawled through Tesco's new six-point plan.
I'm not going to run through the whole thing here (not least because much of it is indeed, typical management waffle). But there are some good ideas. And for me, those ideas revolve around plans to upgrade their stores and formats and invest heavily in internet-related sales.
Developing their click & collect' model; upgrading the website and establishing new online only' stores could be a great use of capital expenditure. They say "The combined revenue and capital investment of these initiatives will exceed £1bn..."
Clearly this is still a lot of cash the six point plan is going to cost practically as much as its dividend. So let's hope shareholders get some reward for it!
This could be a nice opportunity
So far I've tackled the big issues facing Tesco; mainly the dwindling margins on UK sales.
I haven't looked at the international aspect of Tesco's business, though it's something that attracts me to the stock.
So before we leave the accounts, let's just take a quick look at the Segmental analysis'. It's one of the most important notes' to the accounts.
In the P&L account, you'll find the overall figures for sales, costs and profit. But if you want to understand what the business is really about, then you're going to have to drill down and see where the turnover and profits are coming from.
Note 2 (page 27) shows us exactly where Tesco is making/losing its money.
Swipe to scroll horizontally
Sales incl. VAT (excl. IFRIC 13)
47,355
11,615
11,380
660
1,044
Revenue (excl. IFRIC 13)
42,798
10,816
9,878
652
1,044
Effect of IFRIC 13
(550)
(35)
(39)
(2)
-
Revenue
42,248
10,781
9,839
650
1,044
Trading profit/(loss)
2,480
735
525
(158)
168
Trading margin***
5.8%
6.8%
5.3%
(24.2%)
16.1%
*** Trading margin is based on revenue excluding the accounting impact of IFRIC 13.
As you can see straight away, the UK is by far the biggest part of this business, contributing £2.48bn in profit. And if the UK business has got problems, clearly we were right to home in on it. But let's just see what else is going on...
When it comes to margins (how much moneyit makes on the turnover) two figures stand out.
First, of course is the massive negative margin (loss) in its US business. Tesco (like many retailers before it) has lost fortunes trying to get into the US. Many say they should just drop it. Well, maybe. But what these figures also tell us is that this side of the business is tiny. With revenue of just £650m, whatever happens in the US isn't going to matter a great deal.
The second stand-out' figure is the 16.1% margin Tesco makes on its banking division. No wonder Tesco is pursuing banking the margins are an awful lot better than retailing groceries! And it probably explains why they're trying to tap into new markets like telecoms and even estate agency.
Using Tesco's brand to open up new markets for Tesco, both online and offline, could be a fantastic opportunity.
Great cause for optimism
As things stand, Tesco clearly has work to do. Yes,it's given us a credible plan to turn things round. But as always we'll have to wait to see if it can deliver...
I hope that my quick run through of what to look out for in a set of accounts has shown you the key things to look out for and how we can use them to help judge whether management is delivering onits promises.
I can certainly see reasons for optimism here. Tesco is definitely one to watch or if you trust management's words, you may even want to get stuck in straight away?
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Managing Editor: Frank Hemsley. The Right Side is a regulated product issued by Fleet Street Publications Ltd.
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Bengt graduated from Reading University in 1994 and followed up with a master's degree in business economics.
He started stock market investing at the age of 13, and this eventually led to a job in the City of London in 1995. He started on a bond desk at Cantor Fitzgerald and ended up running a desk at stockbroker's Cazenove.
Bengt left the City in 2000 to start up his own import and beauty products business which he still runs today.
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