Tesco Downgraded by Analysts Following Weak Sales

Analysts believe that the British pound’s devaluation after the Brexit referendum will have a near-term impact on UK grocers’ results

Ken Perkins 12 August, 2016 | 2:11PM
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Morningstar equity analysts are lowering their fair value estimate for Tesco (TSCO) to £2.15 from £2.35 to incorporate first-quarter sales weakness. We also note that near-term uncertainty among UK consumers could also lead to additional trading down and out of big stores over the next few quarters, but we do not factor this downside case into our base assumptions for Tesco.

Industry-wide inflation could be a positive for traditional grocers

We don’t anticipate a material change to our long-term assumptions for no-moat Tesco, Sainsbury’s (SBRY), or Morrison’s (MRW) after the Brexit referendum because we’ve already factored weak sales growth and margins into our base forecasts.

That said, we do believe that the British pound’s devaluation after the Brexit referendum will have a near-term impact on UK grocers’ results. More specifically, the weaker pound could drive cost inflation in the UK market given that many firms purchase goods from outside the UK, although many perishable products are purchased from local growers.

Industry-wide inflation could be a positive for traditional grocers, which have been generating negative like-for-like sales growth but positive volume growth for the past few quarters. At the same time, there is a risk that cash-strapped UK consumers would shift more spending to discounters in an inflationary environment.

Over the longer term, it’s difficult to estimate the amount of trading down that might persist, especially given that Tesco, Sainsbury, and Morrison’s have already slashed margins and lowered price gaps over discounters. These actions have driven volume growth at traditional grocers. As such, we believe that the impact of Brexit really depends on the discounters’ willingness and ability to absorb higher costs.

Either way, we believe that unfavourable industry economics, which constrain our moat ratings to none, and competition between traditional supermarkets and discounters and e-commerce will have a market larger impact on future free cash flow generation and investment returns than the Brexit decision.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Sainsbury (J) PLC283.60 GBX0.50Rating
Tesco PLC310.90 GBX1.37Rating

About Author

Ken Perkins  is a Morningstar equity analyst covering consumer packaged goods firms.

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