Tesco Plc - Bank liquidity and capital ratios remained strong

Tesco PLC (LON: TSCO) is a United Kingdom-based leading retailer Company. It serves millions of clients every week through stores as well as online space.

Rationale for Valuation – Buy at GBX 211.60

• The Company increased online capacity, which resulted in higher volumes.
• The stock is offering a lucrative dividend yield of 4.28%, with a minimum 10-years track record of consistent dividend payment.
• In the last five years, the stock has delivered a positive return of ~8.02%, which is higher as compared to the FTSE 100 Index.
• From the technical standpoint, 14-day RSI stood at 41.51, which is supporting the upside movement.

Key Risks

• A changing regulatory environment may adversely affect the activities.
• Also, the Company is exposed to the COVID-19 pandemic, including the closure of retail stores.
• The COVID-19 outbreak is having a short-term seismic impact on the industry.
• The banking and money services are likely to remain gloomy in the short-term.
• Future labour cost increases may impact the profitability of the business.

Recent News

On 7 October 2020, the Company announced the appointment of Imran Nawaz as a Chief Financial Officer (CFO). He will join the Board in April 2021.

Interim Results (for the 26 weeks ended 29 August 2020, as on 7 October 2020)

(Source: Company Website)

• In H1 FY21, the Company doubled the online capacity in five weeks and serving 674,000 vulnerable customers.
• The Company witnessed a strong balance sheet, with net debt of £12.5 billion (down £0.1 billion year-on-year) and retail free cash flow of £554 million.
• In the UK market, food sales were up by 9.2% year-on-year.
• The Company has shown strong top-line growth, with an increase in sales of Thailand, Malaysia and Poland businesses.
• On an actual basis, the total sales in the UK & ROI business surged 8.6% year-on-year while there was a shift in category mix as customers focused more on essential items.
• As activity in banking and money services remained subdued, Tesco bank sales fell 31.4% year-on-year.

One Year Share Price Chart

 (Source: Refinitiv, chart created by Kalkine Group)

Valuation Methodology: EV/Sales Approach (NTM) (Illustrative)

Conclusion

In FY21, the Company expects capital expenditure to be in the range of £0.9-£1.2 billion. It expects an effective tax rate for FY21 of approximately 22%. While in the medium term, the effective tax will reduce to approximately 21%. Tesco is forecasting an operating loss for Tesco Bank of £175-£200 million in the financial year 2021. The Company made a provision for potential bad debts in the banking division. According to the industry, the grocery market is seeing a gradual softening of the more extreme lockdown trends. Moreover, competitive pricing would attract more customers. The stock made a 52-week low and high of GBX 203.70 and GBX 260.40, respectively.

Based on the decent growth prospects, and support from the valuation as done using the above method, we have given a “Buy” stance on Tesco at the current market price of GBX 211.60 (as on 7 October 2020, before the market close at 1:46 PM GMT+1), with lower double-digit upside potential based on 0.60x EV/NTM Sales (approx.) on FY21E sales (approx.).

Centrica Plc – Operating with robust cash flows and liquidity

Centrica Plc (LON: CNA) is a global energy solutions and services provider, which concentrates on satisfying the changing needs of the clients and enabling the changeover to a lower-carbon future.

Rationale for Valuation – Buy at GBX 40.81

• On the liquidity front, the current ratio was 1.04x in H1 FY20, which is slightly higher than the industry median.
• In the last six months years, the Company has delivered a sparkling return of ~28.09%, which is higher as compared to the FTSE Mid 250 Index.
• Tesco has a debt rating of Baa2 from Moody's in March 2020.
• It has strong market positions, with improved underlying gross margins in North America Business.
• From the technical standpoint, 90-day RSI stood at 46.76, which is supporting the upside movement.

Key Risks

• The deteriorated demand in gas amid the COVID-19 restrictions has led to commodity or gas price slump, which can affect the profitability in FY20.
• Any change in regulations and government policies could affect the overall business of the Company.
• Risks related to environment and climate change could hamper the operations of the Company.

Interim Results (for six months ended 30 June 2020, as on 24 July 2020)

(Source: Company Website)

• The Company has maintained good customer service levels, with continued high customer retention.
• CNA has shown robust cash flows and liquidity, with a decrease in net debt of £0.4 billion against the start of the year.
• On a year-on-year basis, the adjusted operating cash flow and free cash flow increased by 34% and 74%, respectively.
• Overall, it has delivered a resilient performance against the backdrop of Covid-19.

One Year Share Price Chart

 (Source: Refinitiv, chart created by Kalkine Group)

Valuation Methodology: Price/Cash Flow Approach (NTM) (Illustrative)

Conclusion

It has shown an improvement in financial performance in the first half of the financial year 2020. The bottom-line performance has improved but remained in the negative zone for the period.  It assumes an increasing trend in the second half of the financial year 2020. Centrica has a strong market position in the UK & Ireland. With the ease in lockdown, it has shown a recovery in demand for energy and normal sales level of services and solutions in the core market. The stock made a 52-week low and high of GBX 29.10 and GBX 95.32, respectively.

Based on the decent growth prospects, and support from the valuation as done using the above method, we have given a “Buy” stance on Centrica at the current market price of GBX 40.81 (as on 7 October 2020, before the market close at 8:24 AM GMT+1), with lower double-digit upside potential based on 3.68x Price/NTM Cash Flow (approx.) on FY20E cash flow per share (approx.).

*All forecasted figures and Peer/Industry information have been taken from Refinitiv, Thomson Reuters.

*Dividend Yield may vary as per the stock price movement.

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