09 December 2014

Nicla Di Palma, Equity Analyst at Brewin Dolphin discusses Tesco's profit warning in an unscheduled trading update today.

Tesco now expects trading profit for the full year to be no higher than £1.4bn (previously £2.4-2.5bn, although this was before the impact of accounting irregularities of £118m in the first half). This implies basically zero UK trading margin. There are several reasons for the reduced profit target, firstly, the change in supplier income recognition and secondly that Tesco is investing more aggressively in service (it added more than 6,000 new employees in store) and price (what Mr Lewis called "selective price investment"). Management did not exclude further price investment as the year progresses.

Management have stated that this profit warning is not related to a deterioration in sales (actually, the trading environment is in line with the first half), but to the issues highlighted above.

We believed that the impact of the supplier income overstatement had been fully disclosed in the interim statement (it was £263m, of which £118m in the first half of the year and the rest in previous years). This is not the case and we are negatively surprised, although management highlighted that this is due to new, more cautious and transparent practices.

More details will be given on 8th January at the Christmas statement. We expect the final dividend to be cancelled and we await to hear more information about how Mr Lewis plans to improve Tesco. We also hope management will be able to sell some of its non-core assets and will be brave enough to close underperforming stores. 

-ENDS-

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