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 the latest figures from the Office for National Statistics, last month consumer price inflation (CPI) jumped to 7%, its highest level since 1992. 

But these figures do not yet take into account the higher energy price cap, which came into force at the start of April. And “pipeline inflation” is still rising fast too – manufacturers raised their prices by 11.9% over the 12 months to March, the biggest jump since September 2008, suggesting there’s plenty more set to feed into customer baskets in the months ahead. 

A retailer that is well-placed to dealing with rising inflation 

This cost of living crisis is clouding the outlook for retailers such as Tesco (LSE:TSCO). The company’s statutory profit before tax rose 220% last year, as sales rose and costs fell. Revenue excluding fuel rose by 6% and the company’s operating profit margin increased from 2.7% to 4.2%. 

However, a repeat in 2022 seems unlikely. The UK’s largest supermarket retailer is exposed to inflationary pressures on two fronts. Not only does it have to cope with rising wage and fuel costs, but CEO Ken Murphy is also “laser focused” on keeping the cost of its wares down, as Tesco does “everything” it can to maintain its value proposition. 

Tesco’s efforts to keep prices low will be key to hanging onto customers as the cost of living crisis bites. The company’s Aldi Price Match promise and Low Everyday Prices initiatives are already yielding results, with surveys showing that consumers believe the retailer is doing more to cut prices than the rest of the market. 

Management has the flexibility to continue to reduce operating costs and return the savings to consumers. 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, removing fresh fish and meat counters, restocking shelves in the day rather than at night, and adding new self-service checkouts.

Tesco could also reduce its staff costs as it rolls out a checkout-free store concept. The company has been trailing this since 2019 at its headquarters in Welwyn Garden City, and it launched the first branch open to the public in London at the end of last year. E-commerce retailer Amazon (NASDAQ:AMZN) is already a leader in this market, having opened 17 till-less stores over the past year. 

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. By transporting fresh produce from Europe by rail, the company has also been able to bypass Brexit-related disruption at the Calais-Dover pinch point. 

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’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-to-earnings (p/e) ratio of 11.7, which is not too demanding. They also yield 4.2% 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. 

Even if the business treads water in 2022, shareholders should see an attractive return on their investment as Tesco continues to do what it does best, provide value for money for consumers.

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