January 10, 2019 / 11:48 AM / 10 days ago

Breakingviews - Tesco festivities will spill into 2019

A woman pushes a shopping trolley past Christmas decorations for sale in a Tesco store in Manchester, Britain November 27, 2018. REUTERS/Phil Noble

LONDON (Reuters Breakingviews) - Tesco had a good holiday. Britain’s biggest grocer sold more than rivals over a difficult Christmas period, doing better across the gamut of food, clothing and general homeware. The company is also managing to launch cheaper offerings to fight off discounters like Lidl without jeopardising its operating margin targets. Its successes merit a higher valuation.

Tesco on Thursday said like-for-like UK sales rose 2.2 percent in the six weeks to Jan. 5 compared with a year earlier. That counts as a win given its rivals’ difficulties. Marks & Spencer on the same day said food and clothing sales fell in the 13 weeks to December 29 and blamed a combination of falling consumer confidence, mild weather, Black Friday and heavy discounting from peers. Food discounting is set to continue. WM Morrison said earlier this week its prices would be slashed.

The UK grocer is swimming against the tide by taking a leaf out of German discounters’ books. Its “Exclusively at Tesco” range, which Goldman Sachs analysts reckon is around 10 percent cheaper than comparable Lidl goods, has been a hit with customers. More people shopped at its stores during the last three months of 2018, according to Kantar Worldpanel. That may help explain why the retailer sold more of its higher-margin premium range. A target of lifting operating margin to 3.5 to 4 percent by 2020 from 2.9 percent in the first half of 2018 is therefore still attainable.

Brexit is the biggest risk. If Britain crashes out of the UK without a deal, grocers may struggle to import goods. That would dent sales. If job cuts follow, customers are likely to shun premium goods. That would derail Tesco’s progress towards its margin target. But barring such calamity, Tesco merits a higher valuation. The company is currently trading at around 12.5 times forward earnings, according to data from Refinitiv. That’s below even peers like Morrisons which have patchier sales growth. Becoming a one-stop shop for penny-pinching customers who want occasional high-margin treats will improve Tesco’s standing.

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