Tesco’s Q1 trading update highlights the robust nature of its core UK business as well as demonstrating its rapidly growing international operations and increasing range of services that differentiates the company from its peers.
As can be seen from the above chart of the FTSE 100 the recent support level of 4300 has been broken.
Risk appetite has deteriorated as fresh uncertainty surrounding the global economy and financial system prompted investors to lock in profits and rotate funds away from beta equities and commodities.
Global economic data has undoubtedly shown an improvement in business and consumer sentiment and green shoots of a recover are developing. This week the ZEW research institutes economic expectations index, which is a measure of economic sentiment, jumped from 31.1 in May to 44.8 in June, which marks the highest level since mid 2006.
However, expectations of a v-shaped recovery appears to have moved ahead of events and comments from Dominique Strauss-Kahn, managing director of the International Monetary Fund (IMF), warned that the worst of the global recession might still be yet to come.
Caution from the European Central Bank (ECB) of further write-downs for the regions lenders also spooked investors, suggesting that banks face another $283 billion in write-downs on bad loans and securities in 2009/2010.
Technical analysis of the above chart shows how the trading range that has been in place since early May has been broken to the downside. The downtrend in the relative strength index (RSI), which has shown that the momentum behind the FTSE has been falling for a few weeks, has been justified and suggests that the index has further to fall.
Major support is seen at 4000, although buyers are likely to enter the market in anticipation of this level, so the minor support at 4110 could limit the downside in the short term. A rapid bounce back up and a close above 4330 might suggest that the recent fall was just a blip, but it is more likely that 4300 could now provide resistance to the index in the short term.
In summary, I believe 4300 is a key level and the recent break below this could initiate a further move lower. However, I do believe that the longer term trend is now higher and many fund managers will be looking to enter the market near 4100, so the downside looks limited at this stage.
Food retailers have been in focus this week, with both Sainsbury’s and Tesco updating the market. Both companies demonstrated excellent sales growth and their own entrepreneurial initiatives to aid expansion going forwards.
However, I regard Sainsbury’s decision to raise money in order to accelerate their store opening program as a risky strategy in light of the current economic environment and ultra competitive UK grocery market. Sainsbury’s balance sheet is one of the more geared in the sector, with an fixed charge cover of only 2.3x while Tesco is 4.7x, which highlights that a downturn in trading could impact Sainsbury’s ability to service its debts.
Tesco’s total sales rose 9.7% (12.6% excluding petrol) in Q1 of 2009 and growth from stores open for more than one year came in at 4.3% excluding VAT and petrol.
The Group’s UK sales were buoyed by the success of a huge range of new discount brands that do not impact on margins, with one in three shoppers taking advantage of the lower prices. The recent re-launch of its clubcard customer program also helped drive domestic sales, with non-food items such as toys, gardening and household goods proving popular.
However, it is Tesco’s international operations that stand them apart from their peers, with sales from outside the UK rising 20.1% in fiscal 2009. One third of total sales came from its international division, with strong growth in Asia and an exponential improvement in its recent US venture of Fresh and Easy stores on the West Coast.
After a mixed start Fresh and Easy appears to be gathering speed as it lured more customers with its revamped food offer and bigger value packs. It is still loss making and due to the increased promotion needed to boost the business it recorded a bigger than expected loss of £142 million in Q1 2009. However, same store sales were up between 30% to 40% in fiscal 2009 and new store openings helped drive business.
International operations will represent a large part of the business going forwards, with three quarters of planned store openings in the coming year coming from outside the UK. The group plans to open one Fresh and Easy store a week and a total of 170 by the end of 2010.
Back in the UK, Tesco’s timely acquisition of RBS’s 50% stake in Tesco Personal Finance in December 2008 added £163 million to UK sales in the first quarter of this year. The group is now planning to capitalise on this side of the business, with the opening of 30 in-store banks by the year end.
Tesco’s Q1 trading update highlights the robust nature of its core UK business as well as demonstrating its rapidly growing international operations and increasing range of services that differentiates the company from its peers.
The shares are currently trading on a forward earnings of around 12x, which puts them at a discount to rivals Sainsbury’s (13.8x) and Morrison’s (13.5x) and I believe this rating is unwarranted.
As can be seen from the above chart of the Tesco the shares have bounced around 17% from their March lows.
The moving averages are turning higher, with both the 50 and 200 day exponential moving averages (EMA) providing support for the shares and suggesting that the uptrend looks set to continue. The RSI has found support at the key 50 level, which is encouraging, as it suggests that momentum remains strong.
If we combine the strong fundamental and technical analysis discussed for Tesco and the limited downside for the FTSE 100 at these levels, I believe the shares are at an attractive level for both short and long term traders.
At the time of writing the share price is 355.8p and my short term opinion is positive. Near term targets are seen at 370.5p, 379p and 396p, with a stop loss marginally below the recent uptrend at 337.25p.
This report was written by Mark Allen – Head of derivatives at Simple Investments Stockbrokers. The writer does not hold a position in Tesco. The material in this report has come from Simply Charts and Tesco’s corporate website.
http://www.proactiveinvestors.com.hk
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