Tesco shares under pressure after disastrous Europe performance

Tesco shares were under heavy pressure on Wednesday after the world’s third largest supermarket reported disappointing interim numbers to the market. Shares fell 3.8% to trade at the bottom of the FTSE 100 today as shareholders digested the news.

The firm reported that trading profits for the first half of the year fell 7.6% to £1.59bn. The drop in profits came alongside flat sales growth of 0.5% for stores open more than a year for its fiscal second quarter. Both trading profits and sales growth were broadly in line with the lower end of market expectations though the real disappointment from Tesco’s numbers comes from its performance in Europe and the unfortunate timing of its earnings release.

Sainsbury’s today also reported a sales growth of 2% for the quarter, which marks a 35^th consecutive quarter of sales growth and is in stark contrast to Tesco who returns to flat growth from a 1% drop in sales last quarter. And so what may have been digested as a slower than expected recovery for Tesco a week ago, today will appear like its falling further market share to Sainsbury’s and budget grocers such as Asda and Aldi, escalating concern.

Sainsbury’s number in truth met forecasts and its own shares price fell 1.6% matching a sector move.

Europe and Profit Margins are a key concern

The real concern for Tesco however was performance in Europe where trading profits fell a massive 68% thanks to ‘challenging economic conditions.’ The company warned that weakness in Europe will counter some of the improvement it expects to see in the UK for the full year. Despite this, Tesco maintains it is confident of reaching its mid-single digit profit growth target.

Realistically, that remains a significant challenge. The speed at which Tesco is returning to dominance in the UK is not of the pace shareholders had hoped earlier in the year and when compared to the performance of its rivals, this is a concern.

In the UK, inflation is at 2.7% whilst average wage growth on a 3 month basis is at a mere 1.1%. This is forcing shoppers to look for more affordable prices and forms one of the key reasons for the rise in popularity of budget supermarkets such as Aldi and Lidl, alongside that of Asda. Will Tesco have to start cutting more prices or offering greater discounts on bulk buys to attract lost footfall to its stores? If so, can they have to at the very least maintain operating profit margins at 5.2% in the UK?

At the same time, the severity of the weakness in European performance has not been matched by some of its rivals in the same market. Weakness has been born out of weak economies, tougher competition and a growing preference of consumers to shop at smaller convenience stores for short term buys, enabling them to manage their budgets on a shorter term basis.

The story on Tesco has turned from turnaround plans to a loss of momentum.

It is easy to understand why Tesco shareholders are unhappy today.

One brighter note for Tesco is the fact that they launching a joint venture in China after reaching an agreement with China Resource Enterprise (CRE) to take a 20% stake in the largest food retail business in China, giving Tesco an additional presence in 3,000 stores alongside its current presence.