FT Alphaville " Tesco's Big Price Drop The share edition that is... And all because the UK grocer announced the following in its RNS trading statement on Thursday: In a challenging economic environment, we made good progress internationally but despite record sales, we are disappointed with our seasonal trading performance in the UK. We will continue the process of change that we started nine months ago to address long-standing business issues, building on the important steps we have already taken in the United States, in Japan and at Tesco Bank, as well as those we have begun to take in the UK. The Big Price Drop is an important first element in this process but there is much more we can do to further improve our shopping trip for customers and we are determined to move faster. We will say more in our Preliminary Results announcement in April. We delivered a very good Christmas shopping experience for our customers but in a highly promotional market, the volume response to our increased investment into lowering prices did not offset the deflation it has driven. The wider improvements in the shopping trip that are an integral part of strengthening our performance are still to work through fully. In other words, Tesco is suffering from Tesco-induced deflation. We imagine Mervyn King might want to have words with Philip Clarke about that. Here are some thoughts from Espirito Santo in the meantime: After a weak Christmas sales performance Tesco has admitted they need to do more to drive the UK business. As such Tesco is guiding to minimal operating profit growth in 2012/13 as they invest in the business. At first glance this implies a 10% downgrade to our, and consensus, forecasts and gives Tesco an additional £400m, or c. 90bps of UK margin, to invest in driving sales. This is the first time that Tesco is deliberately taking profit margins lower that we can remember - profit margins have been at least 5.6% since 1990.Tesco has also confirmed they will reduce capex in 2012/13 as they change their UK expansion plans. Both strategic changes could lead to ripple effects across the industry, with the likely outcome a reduction in industry profitability. In terms of the Christmas performance, total group sales growth for the 6 wks to 7 Jan slowed to +4.2% (incl petrol and at actual exchange rates). Petrol accounted for 1.2% but currency had a negative 1.0% impact so constant currency, ex petrol sales growth was 4.0%. Group growth on this basis has been slowing all year. The UK was the main culprit as LFL ex petrol/ex VAT sales declined -2.3%, weaker than our -0.5% forecast and latest consensus estimates of -1.5% to -2.0%. Tesco admits that its lowered prices have not driven volumes as hoped. Total non-food sales increased, but LFL sales were still negative. Online sales increased 14%, an improvement on the first half; and two-thirds of Tesco Direct orders were collected in-store. International sales were also quite weak with Asian LFL sales growth "modest" (we have +2.2% for the 4Q which looks high now) and Europe LFL sales up +1% (we have +0.6% for the 4Q). On our current estimates the shares trade on 9.4x our cal.2012e EPS including property profits and 11x excluding property profits which compares to both Morrison (MRW LN, 304p, Buy, FV 330p) and Sainsbury (SBRY LN, 302p, Neutral, FV 335p) on 10.4x. Investors have been concerned about the UK business and the issue now is whether the price investment will effect a recovery investors can buy into. We place our Buy rating and 480p fair value under review. There is a call at 8am. And let's not forget that price cutting didn't stop Sainsbury recording a strong Christmas sales period. Related link: Tesco warns on profit after poor Christmas - Reuters This entry was posted by Izabella Kaminska on Thursday, January 12th, 2012 at 8:25 and is filed under Uncategorised. Tagged with Deflation, retailers, sainsbury, tesco, UK.