Higher costs dent Tesco (TSCO Stock) profits

Tesco's share price is still well below the pre-pandemic levels that we saw in February 2020 despite performing very well in the face of some very difficult circumstances.

After an initially shaky start as supply chains creaked and groaned under the strain of the initial lockdown, the entire supermarket sector has been one of the unsung heroes of the pandemic, with management and staff straining every sinew to keep the country fed.

To recognize this Tesco paid all front-line staff a 10% Christmas bonus, which on the face of it was the least they could do given the payment of a special dividend to its shareholders from the proceeds of the sale of their businesses in Thailand and Malaysia for £8.2bn.

Management also took the decision to return £535m of business rates relief from the government, as well as forgoing future rates relief, despite the fact that its increase in costs in terms of recruiting extra staff and safeguarding measures came in much higher at £892m. The investment in online sales were the biggest growth area, a doubling of capacity to 1.5m slots per week while sales grew by 77%, helping to push annual sales up to £6.3bn, with home delivery accounting for 79% of online orders.

Today’s full-year numbers showed that these higher costs, as well as investment in extra capacity, have not only impacted profits, but in facing up to the challenges presented by the likes of Aldi and Lidl revenues, and its “Aldi Price Match” campaign, have also impacted revenues which have come in lower, despite the higher demand due to the pandemic.

While a group like for like sales rose by 6.3%, with the UK and Ireland accounting for 6.8%, revenues including fuel were 0.4% lower from a year ago at £57.9bn.  

This increase in costs is reflected in operating profits which declined 21.3% to £1.7bn, with full year profits coming in at £825m, down from £1.03bn.

While the retail side of the business outperformed, the likes of Booker which supplies pubs, restaurants, and cinemas saw a 40.8% decline in sales. This was offset by an outperformance on the catering side of the business, as well as the inclusion in the sales numbers of Best Food Logistics, which helped grow sales by 10.5%, compared to a year ago.

Tesco Bank made an operating loss of £175m, largely due to higher provision for bad debts, though a return to profitability is expected in the next fiscal year. A final dividend of 0.0595[ [er share was announced.

In terms of the outlook, Tesco said it expects sales volumes to decline as lockdown restrictions ease, however costs are also expected to decline as well. This should translate into better margins, and an increase in profits, which should head back to the levels seen last year.