Tesco PLC cash machine a good haven in inflationary environment,

On Jan 15, 2022

Tesco should remain a business that is capable of producing ongoing free cash flow of roughly £1.5-2.0bn a year, according to Shore’s calculations

Tesco PLC (LSE:TSCO) traded even better than expected over Christmas prompting Shore Capital to increase its full-year earnings forecasts – again.

Tesco, in its fiscal third-quarter update, said it expects retail operating profit to be slightly above the top-end of its previous £2.5-2.6bn guidance range while the supermarket’s bank’s operating profit is tipped to be between £160mln and £200mln, due to the effect of more favourable economic forecasts the company’s provision for expected credit losses.

“We will finesse our figures once we have spoken to management, but we see scope to increase our present retail operating profit forecast of £2.576bn and Bank estimate of £130mln,” Shore Capital said.

“We sense we could be increasing our FY22 PTP [pre-tax profit] forecast by c5% to c£2.15bn (EPS 21.8p),” the broker added.

The broker commended newish chief executive Ken Murphy for his helmsmanship since he got his hands on the rudder in October 2020, slap bang in the middle of what Shore calls “lockdown 2.0”.

“Hamstrung by official controls and much uncertainty his early months, most of which was outside of his control, Tesco has evolved well in CY21 [calendar year 2021] in our view as pandemic controls eased, Mr Murphy’s new CFO [chief financial officer], Imran Nawaz started to have a positive effect, and the group’s trading strategy, which was largely put into place by the now Sir Dave Lewis, took hold. Whilst somewhat functional, Tesco’s operating strategy is proving to be very effective, set around consistently high basic store standards and an evolving value proposition built on the core offer, Aldi Price Match and, increasingly, aforementioned Clubcard Prices,” Shore said.

That trading strategy led to upgrades at the halfway point of the current fiscal year plus the commencement of the £500mln share buyback, which Shore welcomed.

The broker reiterated its ‘buy’ recommendation, saying the “equity can build a reputation as a cash compounder”.

Shore predicts the Bank of England will have to bump up interest rates more than it currently seems prepared for and for longer.

“As such, asset-backed, cash generative, liquid, and defensive stocks like Tesco may just be a good place to have a presence as the times are a changing,” the broker concluded.