Company and Sector Overview

Tesco operates under the tertiary sector, providing retail, banking, mobile, oil services and many
more to customers worldwide. The company has become a market leader in the last 25 years,
dominating the supermarket sector with 27.4% market share (market share) as of October 2023
and having 4,859 stores operating globally as of April 2023(statista stores).

One of the biggest retail sectors in Europe is located in the UK, thus it contributes greatly to the
national economy of the country. In 2022, the UK retail market had a value of GBP 386.3 billion.
Supermarkets hold the biggest value share and are expected to increase at the fastest rate
over the next several years (Global Data,2022). From 2022 to 2027, the market is anticipated to
expand at a compound annual growth rate, or CAGR, of over 2%.

Founded in 1919, Tesco was first a market stand in East London by Jack Cohen. Its brand
name was created by combining the first two letters of the owner 's last name with the first three
characters of T. E. Stockwell, his tea supplier. The motto for Cohen's business was always
clear: "pile it high and sell it cheap." Tesco became publicly listed in 1947 in the London Stock
exchange and the next couple of years the company had more than 500 stores (Business
Insider, ).

Grocery sales in the UK typically adhere to a fairly predictable trend throughout the years,
though the COVID-19 pandemic proved to fluctuate consumer preferences and habits ( COVID)
to which retailers had to adapt quickly and effectively. Despite incurred costs from employee
absences, lost productivity and health requirements, Tesco was able to take advantage of the
closure of the pandemic and the inflow of online and physical consumers by mobilising supply
chain networks and effective digital marketing (Tesco forecasts ‘strong’ recovery after £900m
pandemic hit). The business saw that average basket sizes stayed greater than pre-pandemic
levels even with fewer shopping trips and a growth in revenue of over £680m from 2020/21 to
2021/22 (Preliminary results 2021/22 (tescoplc.com)). A further measure taken by Tesco after
the pandemic was the launch of a price-lock campaign on over 1000 everyday products, to
show the company’s acknowledgement of inflationary pressures on consumer expenditure and
help stimulate customers to choose Tesco over its competitors (price locked).
Creating "magnetic value for customers" is one of Tesco's top strategic priorities. Combining
good quality, affordability, variety, and customer experience is all part of this approach. The
objective is to provide dependable value that reduces the need for clients to look for other
places to shop while giving them good reasons to make more purchases (Prakash,). Another
strategic move from the company is the creation of Tesco Clubcards which are used to gather
data in order to personalise and enhance the shopping experience for the buyers and increase
brand loyalty. In addition, this step is essential for Tesco as it is a move toward automation and
AI personalization, while simultaneously enabling the company to develop a more in-depth
analysis on consumer trends and apply changes to the operations and reduce unnecessary
expenses. In order to manage the impact of inflation and finance its strategic priorities, the
corporation strives to be as easy to operate, productive, and flexible as possible(Parakash,).

Furthermore, in the future Tesco is striving to continue its digital transformation. With respect to
evolving market dynamics, technological advances can offer businesses complete supply-chain
transparency along with real-time insights and data to support immediate and effective decision-
making (Harvard,). With the help of artificial intelligence, the internet of things, statistical
analysis, and other transformational tools Tesco could think ahead and adjust rapidly to demand
and supply trends.

Through pragmatic means of leadership and corporate decisions taken by the company over the
years, Tesco has dealt with both internal and external threats and opportunities. This analysis
will provide a snapshot at different time periods based on changing macroeconomic aspects
and internal factors within the company which have impacted the company’s standing in various
key financial metrics to investors. The following analysis aims to prove that the company has
effectively defended the shareholder interest throughout the changing environment, while
highlighting both strengths and weaknesses.

Asian sale

The key event which has had continuous impact on the company both prior and post COVID 19
was the sale of Tesco’s division operating in the Asian market. At first glance this contractionary
action might be considered as a negative due to the weakened geographical diversification.
However, what it in fact provides is a concentration on the key European markets, while still
allowing the company to take advantage of risk-reducing sector diversification benefits - i.e.
apart from grocery retailing, the group still operates in banking, fuel sales, appliances retailing
and others. This action has had an impact on the income statement as seen by reduction of
9.91% revenue from 2019 to 2020, however, this proved to actually have positive effects on the
long term performance of the company. One of the main advantages that the group had after
the sale was the increased liquidity as can be seen from the improved current ratio which went
from 6.1% (2018) and 6.2% (2019) to 8% in 2020. The generated cash from the liquidation was
used to decrease the indebtedness of the company in the next years as seen by the reduction
of debt by 4.32% in 2020 and 12.86% in 2021. In consequence of that the net finance costs
were reduced over the next few years which gives the company a better standing position in the
volatile markets of 2020 to 2023. With the increase in liquidity and reduction of debt, the sale
proved to be vital for the financial health of the company during the unexpected external
pressure as result of the Pandemic.

COVID 19

While discussing the COVID 19 effects, financial metrics from 2020 and 2021 are taken into
account in order to showcase both the effects of the Pandemic and the corporate governance
decisions that have made the company a good value stock and that have given grounds for high
continuous growth potential. Some of the most important effects following the pandemic which
have had a resounding impact on the retail sector include the change in consumer behaviour
and structural changes in the operations of the markets. Even though, as can be observed from
the reports provided, the overall revenue of Tesco had decreased by 9.11% in 2020,
nevertheless, as aforementioned the decline was a result of the division sale which was
responsible for 83.72% of the overall downturn. Furthermore, the sale of the Polish division of
the company in 2020 accounted for additional lost revenue from the central European markets.
Therefore, the company revenue decline was mainly skewed due to the internal restructuring,
though it can be seen that the UK division had increased its revenue by 2.43%. Even though at
first glance this increase can be overlooked, it is important to acknowledge that it happened
during an overall decrease of 1.9% in the retail markets in the UK in 2020. What this proves is
that the company had in fact improved its market share. More importantly, in 2020 the company
observed an increase in their operating profit margin from 4.1% to 4.4% which could be
attributed to several factors. The company had gained efficiency due to its operation being more
euro-centred, thus avoiding the exponentially increasing distribution costs associated with
exporting to the Asian markets, which were a result of the disruptions in the overall supply
chain. The company had also benefited from governmental grants to deal with the COVID 19
effects which have also impacted positively the profitability of the group.

COVID 19 had a considerable impact on consumer behaviour leading to increased online sales
and changing purchasing patterns. This switch to online retailing had a negative effect on sales
per area metric which is an important part of the structure applied for operations relying mostly
on physical sales. Following this decline, Tesco heavily invested in a new fulfilment centre in
West Bromwich to deal with the changing nature of retail sales. The impact from the
changing nature of the markets is most noticeable in the 2021 income statement of the
group. While the overall revenue had declined by 0.35%, the operating profit had
declined by 30.45% and operating margin had gone to 3.1%. This happened due to new
company initiatives which, even though reflected the necessary changes that needed to
be made, had not been as efficient in the short term. Furthermore, due to government
regulations the company had to employ 50,000 more people to deal with the covid
restrictions further taking a hit on their operating margins. This can be seen as a
negative financial result, however, due to the previous sale of the Asian division the
company had managed to remain more liquid than before 2018 showed by the current
ratio ( 0.76), and had been able to repay the financial grants provided by the
government, further paying out more than 5bn additional dividends to their investors.
Therefore, even though looking at the trend on the income statement 2021 might at first
seem as a downfall for the company, it was in fact the year in which necessary actions
were taken to improve the company standing in the years to follow. The total
indebtedness had decreased by 16.62% considering pre-covid times, overall those
decisions had a positive impact on investors confidence as the stock value had increased
18.12% compared to the 2018 year end price.

Inflation effects 2022 - 2023

After the COVID19 period, the main challenge in the industry and for the group was the
continuous high inflation in the markets. This inflation has a big impact on the financial results of
both 2022 and 2023, however, as it has been discussed previously based on the decision taken
before and during the pandemic, the company's performance had again exceeded the market
expectations. This can be shown by the above average market returns provided to the investor
from march 2021 to 29th November 2023 during which the stock price had increased by 27.1%.
Investors have seen the increased profitability of the company in 2022 when profit margin had
increased to 4.6% from the aforementioned 3.1%. This can be attributed to the efficiency gained
by the capital investments made earlier and the restructuring that was implemented to fit the
changing consumer behaviour. Due to the loosening of the covid restrictions the company had
also managed to become more operationally efficient by reducing the workforce by more than
3%. Furthermore, the company had a strong financial standing with high liquidity allowing it to
further decrease the total debts by 16.98% compared to the previous year, giving investors
further security in the inflation-led volatile markets. Their revenue had increased by 5.97% for
2022 which is higher than the 2.9% market increase. This indicates again an increasing market
share which is likely the result of the increased concentration on their main European markets
and good market placement. In comparison, the key Tesco competitor Sainsbury’s 2022
revenue had followed the market performance, achieving only 2.9% increase, while their
operating margin was 3.86%. This shows that the actions taken by Tesco in response to Covid
and the ongoing inflation were more effective. Looking at the covid times it can be further
highlighted that the operating margin for Sainsbury took a bigger dive, proving it to be more
exposed and influenced to external market volatility. Overall considering the higher operating
margin of Tesco, an investor can assume that their operations are cost effective, which further
will provide a higher return on investment. This is outlined in the comparison of the Return on
Capital Employed metrics for which Tesco managed to return 7.16 in average for the last 5
years which is higher than the 4.11 that Sainsbury provided. The importance of the ratio is that it
shows a potential investor the efficiency that the company has on using their capital which can
have an impact on the profitability in the future.

Considering the most recent estimations of Tesco’s financial performance there is again a
relative decline in the metrics. The decline is industry wide as companies in the sector
continuously battle against the high inflationary pressures on the supply chain side. The high
inflation combined with the competitiveness of the sector has not allowed for the prices to rise
and to adjust the inflation costs to the consumers, thus reducing the operating margins.
Furthermore, the company has experienced a currency hit from the volatility of the Hungarian
markets due to imposed market price caps and currency fluctuations which further decreased
the profitability of the euro-centric company. On the other hand, the revenues have managed to
increase to pre-Covid times for the first time by growing by 7.20% compared to 2022. This
increase is considerable when taking into account the changing market tendency of consumers
being more budget conscious because of the rising prices. Furthermore, Tesco has managed to
keep its market share with the entrance of German discount chains such as Lidl and Aldi
gaining more market presence. The big portfolio of products and services that Tesco offers has
managed to deal with the changing market as Tesco’s own products have managed to increase
sales by over 7% for the luxury segment and budget items at 6%. Moreover, high fuel costs
have given the group another way of increasing their group sales showing that a diversification
is achieved which helps combat various market conditions.

Financial Ratios

Liquidity /Current ratio - As discussed before the company has managed to increase its
liquidity by the Asian sale which has provided an overall improvement of the current ratio. At the
current time the ratio is at 72.95 which is close to the average of 73.125 and should provide
confidence to the investors. Comparing it to the Sainsbury’s ratio we can see that Tesco is more
liquid on average and is in a better position to deal with unexpected financial pressures.

Debt ratio - Following debt to asset analysis, it can be identified that Tesco has been able to
successfully decrease its debt ratio by 7.06% from 2022, while Sainsbury has only managed to
improve its position by 4.94%, which suggests that Tesco provides higher security from an
investor perspective but also is the reason for the decline in the net financial costs. This could
mean that for potential future investments Tesco shareholders would benefit from higher
returns, due to the lower costs and making the investment more competitive compared to that of
Sainsbury’s.

Return on Capital Employed (ROCE) - Comparing the change in ROCE for both Tesco and
Sainsbury, it can be identified that Tesco has managed to successfully improve its ratio by
10.25%, while Sainsbury has actually seen a decline in the metric of 36.57% from last year,
suggesting that lower portion of the company’s profits can be reinvested, thus producing lower
returns to shareholders.
Cash Conversion cycle (CCC) - The CCC of Tesco on average for the last 5 years is -34.42
days, suggesting that the company is able to sell its inventory, prior to having to pay for the
products sold to their providers. Effectively this means that the providers themselves finance the
operation of the company. Though, Sainsbury’s 5-year-average CCC is still negative it comes to
be higher than its industry peer at -26.56 days, which once again proves that the company is
less efficient in utilising its cash and thus less liquid compared to Tesco’s operations.

Price to earnings ratio (P/E) - The P/E metric is important as it allows for a company value to
be compared to those of the same industry and see if it is underpriced when looking at the
earnings. Higher dividends paid, meaning higher price to earnings. However, a lot of companies
might enhance stock prices by paying out more dividends. Tesco having a lower P/E ratio oF
24.48, compared to Sainsbury’s 29.49, might be considered by a fundamental analyst as a
better buy considering the current market price.

Dividend yield - Though Sainsbury provides its investors with a higher dividend yield (of 5.09%
compared to Tesco’s 4.04%), meaning that the company invests less back in the markets which
could lead to a loss of competitiveness compared to Tesco, hence it is not considered as
sustainable in the long run.

Based on the discussed ratios the overall financial performance of Tesco compared to that of
Sainsbury’s can be considered as more secure and providing higher returns. Tesco has beat
the market levels of growth in terms of revenue, while having a price to earnings ratio to lower
than the industry average. Tesco has provided a sustainable growth by a continuous and
effective corporate governance which has successfully navigated the company’s structure to
changes in the consumer behaviour and different external market factors such as high inflation
and disruptions caused by Covid, and thus has yielded better financial performance than
industry competitors.