Tesco’s profit margins labelled ‘unsustainable’ by HSBC

HSBC has labelled Tesco’s profit margins as “unsustainable”, with competition from discount food retailers continuing to increase as they gain market share.

The bank changed Tesco from ‘neutral’ to ‘underweight’ and cut the target share price from 400p to 340p. Goldman Sachs has also repeated its ‘sell’ rating for the supermarket.

HSBC said, “We believe a 5.2% UK operating margin is not sustainable, and that aiming for any margin is the wrong strategy. In our view, a margin fall is inevitable and a margin reset is necessary. We advocate Tesco slashing its margin to 2-3%.”

David McCarthy, head of European consumer and retail research at HSBC, said, “Cost cutting may help short term, but this is likely to result in ‘consumer unfriendly’ actions, causing further sales declines and creating even more margin pressure. Tesco moved onto this vicious spiral some time ago, and so far, all attempts to break the spiral have failed in our view.”

Instead, McCarthy argued that Tesco should focus on cutting its margins in order to “destroy competitors’ cash flow and profits”.

Tesco announced a decline in its third quarter sales in the UK. Like-for-like sales fell by 1.5% this was blamed on weakening sales in the grocery market. The group also saw sales decline in foreign markets, particularly in Thailand and Ireland.

Last month, Britain’s four biggest supermarkets – Tesco, Asda, Morrisons and Sainsbury’s – lost market share for the first time in over a decade. The fall saw discount grocers Aldi and Lidl increase their market share by almost 1%, the equivalent of around £1 billion.

If the recent trend continues, large supermarkets such as Tesco are likely to see their customer base and profits fall further. As a result, this will impact on investors.

In Blue & Green Tomorrow’s Guide to Sustainable Spending 2013, the UK’s leading food retailers were assessed on sustainability and ethics. Tesco was ranked fourth, scoring 16 out of a possible 23.

Whilst the supermarket scored full marks in the energy and social responsibility categories, its animal welfare and sustainable agriculture and sourcing policies were not found to be as sustainable.

Further reading:

Tesco unveils extent of grocery food waste

Tesco to take ‘leading role’ in reducing food waste

Post-horsemeat burgers, has Tesco returned to business as usual already

The Pig Idea: a campaign looks to pigs to tackle food waste

The Guide to Sustainable Spending 2013