Pound's Brexit Weakness Weighs on Tesco as It Caps Prices

(Bloomberg) -- Even Tesco Plc's vast bulk can't shield it from the effects of Brexit.

Sales growth at the U.K.'s biggest retailer slowed in the latest quarter as the company held the line on prices despite an inflationary squeeze from the weak pound, raising concerns about the strength of Tesco's recovery. Profits are being bolstered by international operations that were long seen as a distraction.

Tesco's domestic business “remains fragile” and the company needs to “significantly improve” its sales performance in order to mitigate rising costs, Bryan Garnier analyst Antoine Parison said by email. The shares fell as much as 4 percent in London, while rivals J Sainsbury Plc and Wm Morrison Supermarkets Plc were down as much as 2.3 percent and 2 percent, respectively.

The company restored its dividend after three years with none, marking a milestone in its comeback from an accounting scandal in which former executives are on trial in London. But the results Wednesday show that Tesco is not immune to the effects of Brexit even though it can deal with price pressure more easily than some rivals. The slide in the pound since the U.K.'s vote to leave the European Union has raised costs for retailers, which have to pay more for imported food as a result.

While Tesco's first-half profit 759 million pounds ($1 billion) beat analyst estimates, the results were bolstered by international earnings. Property transactions provided a further boost of 33 million pounds. Domestic same-store sales rose 2.1 percent in the second quarter, slowing from the previous three months and falling short of analyst expectations.

Operating Margin

The U.K. operating margin was 2.1 percent in the first half, well short of the company's overall target of 3.5 percent to 4 percent by 2020.

Overseas operations in markets like Thailand and Poland are providing a crutch due to the weakness of sterling. Adjusted operating profit rose 40 percent in Asia and more than tripled in central Europe in the first half.

“Tesco's overseas operations give them more to work with financially than their rivals who are wholly reliant on the U.K.,” Bryan Roberts, an analyst at TCC Global, said by phone.

At home, the company has been mending strained relations with suppliers, working with them to keep prices down and narrow a gap with Wal-Mart Stores Inc.'s Asda and discounters Lidl and Aldi.

U.K. grocery prices have risen more than 3 percent across the market for six consecutive months, according to Kantar Worldpanel. Tesco raised prices by about 2 percent across its range, Chief Executive Officer Dave Lewis said on a call, adding that he expects food inflation to continue at a similar pace in the second half.

Lewis said he's comfortable with a consensus estimate for full-year operating profit of 1.5 billion pounds. The company will pay an interim dividend of 1 penny a share.

“We don't see any Brexit scenario as posing a risk to our targets,” the CEO said at a press conference. “Tesco is no more exposed to the risks than anybody else.”

To contact the reporter on this story: Sam Chambers in London at schambers7@bloomberg.net.

To contact the editors responsible for this story: Eric Pfanner at epfanner1@bloomberg.net, Thomas Mulier