Tesco looks well-placed to ride out the cost of living crisis – investors take note
Surging inflation is bad news for retailers. But supermarket giant Tesco looks better placed to cope than most, says Rupert Hargreaves.
The cost of living crisis is only going to get worse for consumers. According to economists, the UK is expected to have the highest inflation in the G7 not just this year but also in 2023 and 2024 as the country is far more exposed than other regions to rising energy prices.
Many European countries have placed strict limits on household energy bills while other G7 nations, such as Japan and the US, are much more self-sufficient in gas and other types of energy. Higher energy prices account for around half of the UK’s inflation rate.
A retailer that is well-placed to dealing with rising inflation
The cost of living crisis is both good news and bad news for Tesco (LSE: TSCO). On the one hand, reduced consumer spending will hit sales, but on the other, by keeping costs low the business could grab market share.
And it seems as if that’s just what’s happening.
The company’s Aldi Price Match promise and Low Everyday Prices products recorded volume growth of 19% year-on-year during the 13 weeks to the end of May helping Tesco grow its overall market share.
Alongside these numbers CEO Ken Murphy said the group is “laser focused” on keeping the cost of its wares down as Tesco does “everything” it can to maintain its value proposition. Overall sales for the period rose 2%. Growth at the firm’s Booker wholesale arm jumped 19.4% as large events returned to the social calendar.
What I really like about Tesco as a company is its size, diversification and flexibility.
To cope with inflationary forces, Tesco plans to reduce costs by £1bn over three years by streamlining its property footprint and cutting head office costs. It is also re-thinking the way staff are deployed in stores and there’s scope to reduce costs with a new checkout-free store concept. It has been trailing this since 2019 at its headquarters in Welwyn Garden City. The cost savings of these initiatives will be returned to customers via lower prices.
At the same time, its Booker wholesale business, bank and mobile arms provide additional diversification and cash to improve the customer offering.
Cost savings help Tesco dealing with rising prices
Tesco’s supply chain is miles ahead of the competition. It has been able to navigate the UK’s supply chain issues by investing in new and old technologies, such as electric HGVs and rail.
Over the past year, the retailer has increased the number of its containers transported by rail by nearly 50%, with plans to increase capacity by around a third in the near future. Not only is this great for its green credentials, but each train takes around 40 HGVs off the road, slashing the number of drivers required in a tight labour market.
All of these advantages help Tesco stand out in a highly competitive market which is facing extremely tough conditions.
Tesco stands apart from the crowd as uncertainty builds
Right now, I’m hard pressed to find any retailer that looks attractive considering the current economic outlook. Some operators like Next (LSE: NXT) stand out because of their competitive advantages in areas such as order fulfilment. Others, such as Watches of Switzerland (LSE: WOSG) stand out because they target a specific niche, which has a certain level of immunity from cost of living trends.
But for most retailers, life is only going to get harder from here as consumer purchasing power declines and the cost of doing business grows.
Tesco is already noticing changes in consumer behaviour as prices grow. “We are seeing some early indications of changing customer behaviour as a result of the inflationary environment,” Murphy noted in the company’s latest trading update. This makes it harder not just for businesses, but for investors as well to find businesses that can navigate the economic environment.
Tesco’s scale and competitive advantages help it to stand out. If it can keep prices low for consumers, and keep a lid on costs, it should be able to navigate the storm. Granted, it seems unlikely the company will be able to repeat last year’s growth, (it is guiding for adjusted operating profit from operations of £2.4bn to £2.6bn this year, compared to £2.7bn in 2021) but these challenges already seem to be baked into its valuation.
The shares trade on a forward price/earnings (p/e) ratio of 11.9, which is not too demanding. They also yield 4.3% following the firm’s latest dividend hike. Further, Tesco has earmarked £750m for share repurchases over the next year, equivalent to an additional 10p per share cash return.
Tesco is a slow-and-steady retail giant and it’s unlikely to produce market-beating returns in the long run. However, in an uncertain macro environment I think the business has multiple qualities that will help it navigate the uncertainty. Tesco could be a safe port for investors who’re looking for somewhere defensive to stash their money until the storm passes.