Tesco shares dragged by Booker

Tesco’s management is now sufficiently confident with its realignment with 21^st century consumer habits to resume dividend payments.

Renewed confidence, resumed dividend

That’s the rationale offered by CEO Dave Lewis, and it’s plausible. Operational and financial efficiency improvement is unabated since he joined in 2014. There is, however, another motivation for a move which has come earlier than many investors were expecting. Tesco shares have sharply lagged those of smaller rival Morrisons this year, and, to a lesser extent the benchmark index, despite group progress across most metrics. And investors have still signalled clear differentiation amongst supermarkets. We think the underlying discount is due to uncertainties over the Booker buy. The CFO said on Wednesday morning that the deal is on track for completion, notwithstanding enhanced CMA scrutiny, with an announcement expected later this month. Since we’ve always seen benefits of the combination as only somewhat better than neutral to begin with we would consequently see the impact of non-completion as moderate. But it is still easy to see why the market has remained cautious around the deal in view of the capacity for distraction.  On Tesco’s side, whilst the intended acquisition is already largely funded from cash of around £777m, the new Tesco has an eye to all systemic financial outcomes. Renewed pay-outs will help underpin sentiment for those shareholders who, like us, see the merits of the purchase as less than compelling.

Beyond Booker

Assuming the deal is eventually done, we would expect any share price discount to dissipate. After all, this is the Tesco long-term shareholders have sought for years: one which is consistently delivering better than expected profits, as per the first-half’s 27% rise to £759m. The tailwind for International looking is also increasingly attractive; suggesting views on full-year profits will almost certainly see a small upgrade. Elsewhere, significant pension deficit progress appears to have been widely underappreciated. The most immediate risk for the group is that the CMA may either reject the Booker buy outright or mandate unattractive conditions. Even then, we would still expect the stock to close the year with gains, based on the view that Tesco could scarcely be handling the consumer outlook more adroitly.

Chart

Once again Tesco shares have reversed at the same resistance that has capped the stock for coming up to two years: c. 190-197p. It is tempting to see the latest setback as pointing to a likely sharp selloff but seen another way, we could also say that the stock has been resilient for the same length of time with contained downside. With major support this year at 173p we would not expect the current down leg to exceed that level though if the price overshoots, there is little clear support to prevent the stock from heading towards a previous declining trend line and particularly the kick off point of Tesco’s most recent up leg near 165p. If even that fails to hold, a revisit to August 2016 lows at 153p could be on the cards.