Tesco's first-quarter U.K. like-for-like sales have declined 3.7%, as intense industry competition, price deflation, and reduced promotional spending affected results. We expect these trends to continue over the near term. The relationship between food prices and consumer incomes is returning to a more normalised level – food inflation has outpaced wage growth over the past several years, and hard discounters Aldi and Lidl have capitalized on the opportunity to capture share of cost-conscious consumers' spending.
However, we still think Tesco will remain a dominant player in the U.K. market, and for those looking for exposure to the U.K. grocery space, we think Tesco's valuation remains most attractive relative to our £3.80 fair value estimate.
Tesco noted that about one half of its underperformance relative to the market was due to its decision to reduce promotions by about two thirds. Last year, for example, Tesco would offer a customer £5 off a future purchase of £40 if the customer spent £20 initially. This strategy helped the firm to drive traffic and volume, but did not necessarily cultivate loyalty.
Thus, Tesco's decision to reduce these offers affected traffic. Despite the near-term challenges, we think more focused price investments on core items will help Tesco keep its most loyal customers coming back over the long term. The company recently implemented a fuel savings program and continues to lower prices across its product range, moves that should help to drive traffic. However, switching costs are virtually non-existent in the grocery space, which restricts our moat rating for Tesco, and the company may be forced to further invest in price (at the expense of margin) if competitive conditions intensify.
International like-for-like sales declined 2.2%, largely driven by lower sales in Asia, Slovakia, and Ireland. Tesco faces stiff competition from the discounters in Ireland, while political disruptions in Thailand have weighed on growth. We believe the economic and competitive environments could remain challenging for Tesco in these regions, but encouragingly, like-for-likes sales increased in the Czech Republic, Hungary, Poland, and Turkey.
Overall, the international segment's results have a meaningful impact on consolidated results, but given that the U.K. segment's results are the primary driver of the company's total performance, we think generating positive like-for-like sales growth in the United Kingdom will remain a top priority of management.
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