A Tesco sign is displayed outside one of its stores in Altrincham (photo by Nathan Stirk/Getty Images).
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Despite popping on the day of the release of its interim results, the Tesco share price (LON:TSCO) looks to have peaked. With the shares struggling to breach their 450p price ceiling, I reiterate my previous call that further upside for the stock is limited at this juncture.
The Proof was in the Pudding
Tesco’s interim results were a pleasant surprise – perhaps not so much on the top line, but more so on the bottom line. Group revenue increased 3.6% to £36.04 billion, driven by UK and ROI sales, which were up 5.6% to £24.67 billion and 6.4% to £1.54 billion, respectively. Booker also realised a decent gain of 2.4% to £4.73 billion, with Central Europe a healthier 4.4% to £2.11 billion. Meanwhile, fuel sales fell 9.8% to £2.99 billion.
The main revelation came in the form of gross margin, which ticked up 6bps to 7.88% amidst loftier commodity costs. This, however, was offset by the more expensive labour costs from higher employers’ national insurance and minimum wage, as EBIT margin declined 9bps to 4.65%. Be that as it may, EBIT was still 1.5% better at £1.67 billion thanks to stronger sales as a result of lofty market share gains, and the firm’s Save to Invest cost savings programme.
Consequently, pre-tax profits rose 2.3% to £1.41 billion. This was helped by the fact that net finance costs were slightly lower from last year, at £263 million from £269 million the previous year. And with a tax rate of 26.9%, attributable profit grew 2.1% to £1.03 billion. Nonetheless, thanks to the impact of share buybacks, Tesco’s EPS had a much more meaningful increase of 6.8% to 15.43p.
Marginal Gains in H2
As a result of the stellar half, management upgraded its guidance for the year, going from a range of £2.7-3.0 billion to £2.9-3.1 billion. Whilst I had expected an upgrade on the lower end of the guidance by £100 million, the £200 million boost on the low end alongside the extra £100 million on the high end was a welcome development. But considering the better-than-estimated margins in H1, the guidance is well suited and arguably still a bit conservative.
When questioned on the earnings call on the rationale behind the guidance upgrade, the board mentioned that their outlook is still contingent on market competition not intensifying further – and I agree. That said, Tesco is unlikely to realise the same gross margin appreciation in H2 due to less favourable weather, the EPR levy, and a still intense pricing environment with Christmas expected to be as competitive, if not more.
In addition to that, I believe the continued UK market share gains of 0.8% which Tesco enjoyed towards the end of Q2 won’t be sustainable going into the winter. This would, therefore, limit the gross margin growth potential which Tesco benefitted from stronger economies of scale in H1. In fact, I’m forecasting market share gains to slow slightly, not helped by the tougher Y/Y comps the company is also lapping.
Pegged to Perfection
So, what’s next? Well, for FY26 through to FY28, I’ve dialled down my previous revenue forecasts by a tinge. One of the reasons for this is slower market share gains than previously expected moving forward, with ASDA’s decline bottoming out. Another is from a more modest growth outlook for ROI, as I anticipate competition across the Celtic Sea to remain hot for the foreseeable future despite the progress Tesco has made.
ASDA Sales Still in Decline Despite Rollbacks
Interpretiv
Nevertheless, this is largely offset by my bottom line upgrades in EPS. Because of the better margin mix Tesco is leaning towards (more discretionary items, online orders, Tesco Finest uplift), I have conviction that these will serve gross margins well. Combined with the impact of AI on efficiencies and the build out of Tesco’s digital proposition, I see plenty of opportunities for Tesco to build on its margins over the medium term.
As such, I expect the FTSE 100 stalwart to finish the year with an EBIT that’s slightly above the guidance the team has given, at £3.13 billion – exactly the same as last year. Interpretiv also has the group’s EPS CAGR at 11.2%, roughly unchanged from a previous 11.7%. However, with a PEG ratio of 1.4 against the blended sector and 5-year average of 1.6, I don’t see much upside for the Tesco share price. Thus, I reiterate my price target of 450p.
