Tesco gives investors some food for thought: Grocer pays rare dividend

Britain’s biggest supermarket was set up in 1919 at the height of the Spanish flu epidemic.

Today Tesco has a commanding 26.9 per cent share of the grocery market, thanks to a strategy of offering value under such celebrated slogans as ‘pile-em-high, sell-em-cheap’ and Every Little Helps.

During the current pandemic it’s a proposition that has appealed to even more shoppers, and Tesco has this month gone on the offensive to retain this new clientele.

The £21billion business – the largest of the quoted supermarkets – is reporting to be asking for price cuts of as much as 50 per cent from its suppliers. 

These negotiations are of crucial interest to shareholders. Many are wondering why Tesco’s shares are 12 per cent lower than a year ago, despite the company’s commercial and charitable lockdown feats. 

Tesco increased sales, supported food banks and doubled its online shopping slots to 1.3m a week. To get an idea of the scale of this achievement, it is equivalent to adding two Ocado-sized businesses in the space of a few months.

Tesco’s response, aided by a ‘doomsday’ event rehearsal in 2016, has resulted in higher staff and other costs which means that profits are likely to remain flat.

But the company is ranked among the Pandemic Philanthropists, companies who, in the opinion of Interactive Investor, the wealth manager, should suit those who want a lightly ethical flavour to their portfolio.

Yet Tesco dares not be complacent, amid concerns that Aldi and Lidl could lure back lost customers. In lockdown, Tesco’s stores have been seen to provide better social distancing and, in the early weeks, more stock.

A decade ago, in the wake of the global financial crisis, these German-owned discounters captured cash-strapped customers from Tesco. 

Anxious to avoid a repeat, Tesco has introduced an Aldi price-match and is requiring suppliers to be flexible, a bold move since the mishandling of this relationship lay behind the biggest crisis in the firm’s 101-year history.

The revelation in October 2014 of a black hole in its accounts, arising from the rogue accounting treatment of payments to suppliers, caused a 92 per cent drop in profits. 

‘Drastic’ Dave Lewis, the chief executive brought in to rescue the business, has successfully tackled the cultural and managerial defects that precipitated this catastrophe, reshaping the business by selling off international operations and focusing on food, rather than sidelines such as garden centres. 

Mission accomplished, Lewis is standing down in October, but the supplier stand-off shows that he is ready for one last tussle.

Opinions are divided as to whether a successful outcome could boost the shares: when Lewis arrived in September 2014, they stood at 224p, against 214.6p today.

Over the same period, Ocado shares have soared from 318p to 2140p, propelled by the conviction that its technology is, at some point, destined to overshadow even the most admirable online efforts of the traditional grocery players.

The removal of Ocado from the performance benchmarks used to set Tesco boardroom pay was a tacit, if controversial, recognition of this assessment.

The more immediate prospects for Tesco depend on its ability to strike more competitive deals with suppliers and expand its online activity, at a time when there is new competition from the joint venture between Ocado and Marks & Spencer.

Under this tie-in, M&S food will be available in place of Waitrose fare from September.

Natalie Berg, of NBK Retail points out that ‘ecommerce tends to be supermarkets’ least profitable channel. If you’re proactively directing customers away from stores then profitability is naturally going to suffer.’

She adds: ‘By adding extra online capacity during lockdown, the big supermarkets will help to drive adoption of online grocery. However, this is likely to ultimately end up benefiting those that do it best – like Ocado.’

This represents yet another challenge for chief executive-designate Ken Murphy, formerly of Walgreens Boots. 

However, Alasdair McKinnon, manager of The Scottish Investment Trust, historically a large Tesco shareholder, is more sanguine: ‘If I were a supplier, particularly of branded goods, I would want to work with Tesco, partly because Aldi and Lidl do not sell branded goods.’

McKinnon has recently reduced the trust’s stake in Tesco because he believes retailers are set to endure a tough period, and because he regards Tesco as having little further recovery potential. 

But he contends that Tesco, which paid a dividend this year (something that become quite rare recently), could reinvent itself as a dividend stock.

This view may explain why analysts’ median 12-month forecast for Tesco is 275p. Reason enough to stick with the shares in the hope that Murphy (who does not seem yet to have a nickname) could outdo even Drastic Dave.