When the UK's biggest supermarket reports on Thursday, will it reinforce the growth story, or provide evidence that even Tesco is beginning to feel the squeeze?
What's expected
Q1 was fairly subdued. UK like-for-like sales rose 1.8% and group sales increased 1%, with Tesco attributing some of the weakness to poor weather and uncertainty surrounding the Middle East.
Analysts expect trading to have improved over the summer. Hargreaves Lansdown says the market is forecasting H1 revenue of around £37.2bn, up 3.1%. Tesco's current guidance is for adjusted operating profit of £3.0bn–£3.3bn for the full year and free cash flow of £1.5bn–£2bn. The £750m share buyback announced earlier this year is also under way.
The shares have performed strongly over one and three years. That means the results arrive with a reasonably high level of expectation already reflected in the SP.
Which is where things get interesting…
The contrarian take
The latest market-share figures don't quite fit the straightforward 'Tesco Juggernaut' narrative.
According to Worldpanel by Numerator, Tesco held 27.8% of the UK grocery market in the 12 weeks to 6 September, down from 28.1% a year earlier. That was the fourth consecutive reporting period showing a YoY decline. Tesco's sales still grew 1.7%, but that was slightly slower than overall market growth of 2.0%.
Meanwhile, Lidl grew 8%, Ocado 13% and M&S grocery sales 14.8%.
Tesco remains comfortably the biggest player in British groceries. But the relative growth rates are worth watching.
There is also an amusing twist. The Schwarz Group, owner of Lidl, is among the parties reported by the Financial Times to be interested in Tesco's Czech and Slovakian operations. So while Lidl continues to take share from Tesco in Britain, its owner is reportedly considering buying part of Tesco's European business.
That matters because Tesco's proposition isn't about being the cheapest supermarket or the most premium. It is about being good enough for almost everyone.
That breadth is a significant competitive advantage. But it also creates a particular risk for shareholders: when expectations are high, a set of results can be perfectly respectable and still disappoint.
What it tells us about the British shopper
Tesco sells to almost everyone, which makes it one of the more useful windows into the British consumer.
The picture appears to be pulling in two directions at once: shoppers are trading up in some categories and trading down in others.
At the premium end, Tesco said its Finest range grew 9% in Q1 and 29% over two years. At the value end, Lidl continues to gain share and Tesco continues to use initiatives such as Aldi Price Match to compete with the discounters.
The squeezed middle is where the battle gets interesting.
There is another clue in the latest totals. Grocery price inflation was 2.3%, while grocery sales grew 2.0%. In other words, shoppers were spending slightly more without necessarily buying more.
The consumer isn't disappearing from the supermarket. They are becoming more deliberate about where, when and how they spend.
For Tesco, the challenge is keeping all those different versions of the shopper under one roof.
That's the paradox: when almost everyone shops at Tesco, Tesco has to be many things to many people. The specialists only need to be exceptional at one thing.
What it tells us about the economy
The most interesting line on Thursday may not be about sales at all. It could be what Tesco says about costs and food inflation.
UK average diesel prices have now passed £2 a litre for the first time, according to the RAC. That matters for a business moving huge volumes of food around the country.
Tesco therefore faces the same basic choice as much of the retail sector: absorb more of the cost increase and accept pressure on margins, or pass more of it on and risk making customers more price-sensitive.
Tesco has some scope to offset inflation through productivity. The company says its Save to Invest programme has delivered more than £2.2bn of savings over four years, with a further £500m targeted this financial year.
That doesn't make inflation disappear.
If management starts talking more openly about passing higher costs through to customers, it would be another indication of just how much pressure is building through the retail supply chain.
The Comms Read
Tesco has several stories to manage besides the headline numbers.
First, what is happening to its growth outlook?
Tesco has an advantage in the amount of customer data generated through Clubcard. That should give management a detailed view of where customers are trading down, where they are trading up and where they are changing their shopping habits.
If market share has softened, investors can reasonably ask for the context behind the number. What is driving it? Which categories are affected? What is Tesco doing about it?
A slightly weaker share figure is one thing. A weaker share figure without an explanation would be rather more interesting.
Second, the portfolio.
The FT reports that Tesco is exploring a sale of its remaining Central European operations. Those businesses generated around £4.5bn of revenue and £115m of operating profit across 561 stores last year. The Schwarz Group, owner of Lidl and Kaufland, is among the reported potential buyers.
Then Sky News reported on Saturday that Tesco is among the bidders for Majestic Wine. The numbers make the attraction fairly obvious.
Majestic operates in a higher-margin category than a traditional supermarket. If Tesco were to acquire the business, there could potentially be scope to apply its purchasing, distribution, loyalty and operating capabilities to a specialist wine business.
But that's the theory. Until something formal is announced, this is just speculation.
Put the two reported situations together and the possible interpretation is: Tesco could become smaller internationally, while focusing on its UK operations and select higher-margin categories.
If management is asked about the direction of travel, explaining the strategic logic would probably be more useful to shareholders than a string of "no comments".
The bottom line
Tesco has delivered a strong performance over the past several years, but the next phase may be more complicated.
The company is still growing. It still has the largest share of the UK grocery market. It has Clubcard data, scale, a large customer base and a substantial productivity programme.
But it is operating in a market where discounters are still gaining ground, premium competitors are growing quickly and customers are becoming increasingly selective about where they spend.
Thursday should give us another clue as to whether Tesco can continue to grow while keeping all those different customers under one roof.
Everyone shops at Tesco. The question is whether they still do the whole shop there.
Disclosure: I am a long-term holder of Tesco shares. This article is my personal analysis and commentary, not a recommendation to buy or sell Tesco shares. Investing involves risk and you can lose money. Please do your own research and consider your own circumstances before making any investment decision.
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