Tesco broker round-up - Barclays, Deutsche Bank, Shore Capital

There was a wide range of analyst reaction after Tesco unveiled interim results, with one commentator saying they contained "the worst performance in 40 years" as profit before tax bombed 92% to £112m and UK trading profits shrank 56%.

To sum up further, first-half results showed revenue down 4.5% to £30.5bn and operating profit down 41% to £937m, beating the very broad consensus but shy of many analysts' expectations, with operating margin contracting by 189 basis points to 3.04%.

The interim dividend was cut by 75% to 1.16p, in-line with previous guidance, and chairman Richard Broadbent announced he would be stepping down.

Deutsche Bank said: "Tesco’s first half profit is technically a beat versus our forecast, 10% on EBIT and 7% on underlying PBT. However, it is clear that the commercial income overstatement will affect H2 profits and management state that 'full year profitability could...be impacted by actions to we choose to take'. We lower our sum-of-the-parts based price target by 20% to 180p, reflecting both lower EBIT forecasts and higher debt and pension deficit."

With a full strategic review having been initiated by new chief executive Dave Lewis, analyst Niamh McSherry wrote: "What is clear is that the new management team need more time, and that everything is still on the agenda."

Retail analyst Nick Bubb cocked an eyebrow at the revelation that of the £263m profit overstatement, only £118m related to first half trading profit. "It is also interesting that Tesco feel unable to give any guidance on full-year profits, given all the uncertainties, and that there is hardly anything about the new strategy for the UK, apart from meaningless words about 'competitiveness' and 'reviewing all strategic options'."

After the management presentation to analysts, Bubb added that he could well see why the market took such a gloomy view of it, with the shares losing more ground after Lewis and co finished speaking. "They spent nearly two hours saying next to nothing, but they did rule out a rights issue for the time being, with all the focus on disposals to prop up the over-leveraged balance sheet. Sounds like a lot of pain is still to come on asset write-downs, notwithstanding the chunky H1 write-offs, as well as some hefty overhead cuts."

Barclays reiterated its 205p price target and 'equal weight' recommendation. Analysts on the food retail team wrote: "Tesco’s interim results have positively surprised us to the extent that its accounting issues have been fully quantified – even if a full explanation must wait. This news therefore eliminates the worst-case scenarios."

They added: "Given that Tesco is focused on the need to ‘do the right thing for customers’ – plus the challenging market backdrop and competitor activity – we expect to see a clear margin impact in H2. We previously forecast a clear step down in UK margin next year, now we bring this forward to 2H."

Barclays cuts its trading profit estimates 14% for the current financial year and around 8-9% for the following two.

With Tesco management not in a position to offer full year profit guidance due to a need to create headroom for the future and stressing the "do the right thing for customers", Shore Capital analyst Clive Black and his unsung sidekick Darren Shirley see "a further risk of earnings downgrades".

With the previously announced 75% cut to the interim dividend to 1.16p and warnings of further headwinds and prioritisation of the customer, Black and Shirley said they expected a similar cut to the full year dividend too.

They added: "We are surprised that capital expenditure is set to remain at £2.1bn. We had felt that this is a variable that could and needs to be managed down more aggressively; no doubt this will come up in analysts' questions as will the cost base and future dividend policy."

In its recommendation, Charles Stanley said: "We expect the turnaround process at Tesco to be protracted and painful. Restructuring is likely to require significant investment and may be disruptive to the business in the near / medium term. The possibility of a further material decline in earnings remains. We do not, however, consider Tesco to be ‘broken’. The company has an extremely strong brand, which customers trust. Over the long term, we see potential for the company to stabilise and begin to rebuild profitability."

Analyst Sam Hart added: "Limited near term earnings visibility and uncertainty over future balance sheet strategy means valuing the company is extremely difficult. We see limited potential for a material rebound in the share price on a one year time horizon and the possibility of the share price drifting lower if further bad news is forthcoming cannot be ruled out. We will be reviewing our recommendation over the next few days, but remain at 'hold' for now."

Cantor's Mike Dennis said the headline figures were ahead of his expectations, although "the task of recovering competitiveness in the UK, strengthening the balance sheet through asset sales and rebuilding the brand with suppliers and customers could take time and is dependent on the macro inflation and strength of the consumer recovery".

He added: "The profit outlook now depends on what route Dave Lewis intends to take to rebuild sales and reconnect with its customer base and lapsed loyal shoppers. First, we believe, he needs to simplify the business via UK and International asset sales, then reconnect with suppliers by changing payment terms and lowering his cost of goods and then start on the long road to rebuilding the Tesco brand with shoppers. Tesco has the most developed multi format strategy and is well placed in the convenience market so should benefit from this growth, but will need, in our view, to redeploy space in hypermarkets to more productive use. All this could take several years but we see some easy wins on costs and cost of goods.