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University ID: 1032971

TESCO
ANALYST REPORT
Volume 1, Issue 1
#1$#1$%#1&

UOB EQUITY REPORT UNITED IN!DOM ARTICLE RESEARC"


University of Birmingham Edgbaston Birmingham B15 2TT United Kingdom Yxa972@bham.ac.uk

FIVE YEAR SUMMARY


We initiate coverage of Tesco with a BUY recommendation at 485.50p. Tescos share price was undervalued and we recommended a BUY due to the company potential for continuous domestic & international growth and development as well as the tremendous performance over the recent economic downturn.

406.10p
26 February 2011

Summary
Recommendation Target price (p) Shares (millions) BUY 485.50 8046 13.93% 0.709 2.34 14.12

ROCE (E2012) Exceptional Performance over and beyond. The four year period rec- Beta orded an increasing revenues (7% on average) and comprehensive in- P/E (E2012) come. And expected to continue to do so for the foreseeable future. International Expansion. Borrowings have increased greatly in light of the reduced interest rate (0.5%) in financing capital (Tesco bank) expenditures and expansion abroad (Mostly Asia). Tescos courage and strength to survive downturn, and potential to outperform. With the financial downturn still looming in the economy. The increase in returns generated on assets coupled with the drop in borrowing costs were some of the main contributors for the continuous growth in return o shareholders. Dividends on the Rise. Tesco has certainly proved to be successful and confident in maximising shareholders wealth. Financial year 2011 revealed the 27th consecutive increase in dividends. P/B (E2012)

MV of Or !"ar# $%are& ('() 32707

Com'a(y O)er)*e+
Tesco is the third largest retail company in the world and the largest British UK retailer - in terms of profit. Tesco has proved to be a highly successful company as it comfortably operates in other sectors i.e. health, financial services - apart from its specialty, food and drinks. It operates globally in around 14 countries and continuously to gain a fine edge over its competitors (Tesco, 2013) in its ability to operate profitably, even during recession periods. Appendix 1.1 summarises Tesco SWOT analysis which reveal its strengths, weaknesses, opportunities and threats.
(Tesco, 2013)

O,-e./*)e o0 Re'or/
This report will examine and analyse the financial statement for Tesco for the past five years - 2008 to 2012 (including 2012E forecast). This report is divided into three different sections for full detail breakdown for analysis and interpretation purposes.

The first section of the report will analyse Tescos financial performance (Credit status and ROCE - profitability) over a four year period through the use of various useful financial analysis tools such as ratio analysis and common size analysis, in order to give a clearer transparency on Tescos performance. Tescos ratio performance will be analysed and compared with that of one of Tescos peer and major competitor - Sainsbury J Plc and the industry mean average where ever possible from a reliable source (industry average as at 26/02/2011 - Thomson One Banker) - Appendix 3.3. The second section will involve the exercise of using the common size analysis, analysts projected revenue figure (2012E) and CAGR model to forecast the financial position and performance (Income Statement) of Tesco into its fifth financial year (2012) - this will be compared with its actual 2012 performance. In addition, I will utilise the annual compound growth model in order to form my perspective on Tescos forecast income statement. Finally, the final section will attempt to calculate the - companys forecasted value of equity per share at the end of the fourth -financial year by using one equity valuation model (the Residual Earning model).
Share price movement between Tesco (Blue Line) and Sainsbury (Red Line) from 20082011

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Reformulation
In order to make an effective equity analysis of Tescos financial position and performance through the use of ratio analysis, the financial statements (i.e. Income statement) were reformulated. Reformulation separates the operating and financing items in the financial statement, compared to the traditional credit analysis which classifies them into current and long term categories (Penman, 2010). Penman (2010) reveals that a benefit of reformulation allows additional information to be brought from footnotes. The profitability analysis (ROCE) is broken down into three distinct levels. The first level is the separation of operating and financial profitability and the effects of leverage. The second break-down level are the drivers of operating profitability. Finally, the third level containsProfit margin drivers, asset turnover drivers and analysis of Net borrowing cost. I will evaluate the three break-down levels of profitably (excluding the full break-down analysis of net borrowing cost - due to lack of sufficient information in the annual reports). In addition to these ratios, I will also calculate other Credit ratios to assist in solidifying my analysis.

!e "nalysis of Profitability #Ratios$


Ratio analysis for TESCO PLC: Ratios (Level 1 & 2) Abbreviations 2008 2009 2010 2011

Return on Common Equity Return on Net Opera ng assets Opera ng ro!t "argin Asset #urno$er %inan&ia' (e$erage Net ,orro-ing Cost

ROCE RNOA
PM

A#O %(E) N,C RNOA . N,C %(E) / 0RNOA.N,C1


OLLEV

Opera ng (e$erage
Ratio analysis for J SAINSBURY's: Ratios (Level 1&2)

0.21 0.13 0.05 2.44 0.*3 0.001 0.13 0.08 0.51

0.14 0.08 0.04 2.13 0.+* 0.01 0.07 0.07 0.*4

0.15 0.11 0.05 2.28 0.70 0.04 0.07 0.05 0.71

0.17 0.12 0.05 2.35 0.5* 0.03 0.0+ 0.05 0.74

Abbreviations

2008

2009

2010

2011

Return on Common Equity Return on Net Opera ng assets Opera ng ro!t "argin Asset #urno$er %inan&ia' (e$erage Net ,orro-ing Cost

ROCE RNOA
PM

0.14 0.11 0.04 2.53 0.43 0.04 0.07 0.03 0.42

.0.0+ .0.04 .0.02 2.87 0.50 0.05 .0.0+ .0.05 0.50

0.10 0.08 0.03 2.7* 0.4* 0.01 0.0* 0.03 0.47

0.12 0.10 0.03 2.7* 0.41 0.02 0.07 0.03 0.4*

A#O %(E) N,C RNOA . N,C %(E) / 0RNOA.N,C1

Opera ng (e$erage

OLLEV

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!e "nalysis of Profitability #&ont'($

ROCE (200)*2011)
0.25 0.2 0.15 0.1 0.05 0 .0.05 .0.1 .0.15

ROCE (profitability) for Tesco and J Sainsbury's were positive over the four year period - except for Sainsburys in 2009 where their profitability was negative. In 2009, Tescos profitability also declined. However,
#es&o 2 3ains4ury5s

ROCE (%)

for both company after 2009 there was steady growth in their ROCE. The decline of ROCE in 2009, could have been due to the aftershock of the credit crunch and after this

2008

200+

2010

2011

Year
ROCE movements of Tesco & Sainsbury's between the four year period.

year there was improvements. We would need to break down the ROCE into different levels in order to evaluate in detail and try to explain their respectively effects on the overall ROCE.

RNOA for both retailers were growing steadily after 2009, although Sainsburys experienced a negative RONA in 2009 (Tesco also experienced a fall in this ratio in 2009). It seems as though the recession

affected Sainsburys more than Tesco even though they operate in the Asset Turnover (efficiency) for Tesco and same industry - Tesco are the market leaders in the UK market and are Sainsburys averages at 2.30 and 2.73 reable to resist the shocks of downturns in the economy better than its spectively. Over the four year period it has

competitors. In Tescos defence for the fall in RNOA in 2009 was due been fairly stable. Even though 2009 has to the decline in Operating Income in comparison to 2008. The causes been the main focus when analysing the othof this must have been the losses on the benefit pension scheme and foreign currency translation differences. During this time the global market was still unstable and losses were made on investments and overseas transactions. Sainsburys had a negative Operating Income in 2009, although they were able to cover their cost of sales - other costs exceeded their incomes. In addition to the negative impact on RNOA was the losses made on pension schemes and lower finance income subsequently in 2009 for J Sainsburys. Operating Profit Margin (PM) was rather stable for both retailers in years 2008, 2010 & 2011 - apart from in year 2009 where both company had a decline in PM (negative in the case of Sainsburys). Although both retailers had an increased revenue in all four years the operating margin does not seem to be influenced favourably. One reason for the fall in this ratio in 2009 was due to the reason stated above (RNOA). During the rest of the other years, the stability in the ratio was caused by price wars during the recession periods. Other retailers such as Morrison's and Asda were forced to drop their price in order to compete. This explains the continuous rise in revenue, but also a proportionate rise in costs means the ratio is kept rather steady. er ratios. Surprisingly there was an adverse impact on Tesco ATO while J Sainsburys triumphed during 2009. Although Tesco generated a much higher revenue than Sainsburys during this particular period, it can be concluded that Sainsburys were more efficient in using their Net Operating assets to generate revenue - Tesco were inefficient. It is evidently clear from various sources that Tesco adopted a low-cost strategy especially during 2009. This must have trigger an anticipatory increase in demand and subsequently sales. Looking at the cash flow statement (Cash Investment) Tesco therefore invested heavily, the highest investment over the four year period - especially the extensive purchase in PPE and Investment property. Sainsburys on the other hand invested less in PPE. Thus if Tesco ought to improve their ATO they needed to recognise cautious peri-

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Profitability "nalysis #&ont'($


- ods so investing in operating assets could be minimised. The analysis of both retailers level three break-down for ATO drivers (Appendix 1.2) looks fairly similar - PPE and Inventory turnover dominating the overall ATO ratio.

,O,+- BORRO./01$ (200) * 2011)


20000 15000

'M

10000 5000 0 2008 200+ 2010 2011

FLEV (Financial Leverage) - Tesco were much more highly geared in comparison to Sainsburys. Especially in 2009 FLEV ratio for Tesco was at 0.96 while Sainsburys stood at 0.50. The reason for the high gearing is due to the dramatically fall in interest rates to 0.5% in 2009 (BBC News, 2013) in the UK and also Asia (Japan). The government made it relatively easier to borrow funds in order to stimulate the economy. Tesco took advantage of the historic low interest rate

#es&o 3ains4urys YE+R$

Net Borrowing costs (NBC) - effective cost of borrowings for Tesco was lowest during 2008 and 2009 and a sudden increase in 2010, followed by a drop in 2011. Unlike, for Sainsburys its NBC ratio was highest during 2008 and 2009 and lowest during 2010 and 2011. From the Chart

drop while Sainsburys, still played very cau- above and the line graph below are connected and it extiously. During this year Tesco borrowed plains clearly why both retail firms experienced differences 16,450m (highest over the four year period in their Net borrowing costs. In 2010, Tescos finance costs in comparison to the previous year - were at the highest over the four year period as outstand8,056m. After this year borrowings in 2010 ing borrowings increased in the previous year. But in 2011, & 2011 didnt drop as far to 2008, rather when borrowings started to decline, this is reflected on the stayed close to 2009 borrowings. NBC ratio - as financial costs also started to drop.

On the other hand, Sainsburys increased In the case of Sainsburys, finance costs rose steadily over borrowings from 2008 to 2009 was 129m three years and dropped to its lowest in 2011. Its NBC racompared to Tesco 8,394m. In my opinion tio was expected to drop in 2011 as finance costs declined.. Sainsburys could have been reluctant to borrow due to the unstable financial markets. Although, borrowings are cheap it can bring financial distress to the firm. However, on the positive aspects of extra funds to support
(%)

0BC (200) * 2011)


0.050 0.040 0.030 0.020 0.010 0.000 2008 200+ 2010 2011 Year& #es&o 2 3ains4ury5s

operations,

according

to

Modigliani

and Miller's models (Arnold, 2012) an increase in borrowings lead to a potential increase in returns to shareholders.

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Profitability "nalysis #&ont'($


instead it rose again. This was due to a slight decline in borrowings and increase in Financial Assets. Operating Spread (SPREAD) (RNOA>NBC) - was favourable during the four year and three year (08 10 and 11) period for Tesco and J Sainsburys respectively, where Positive spread is likely to generate higher return for shareholders as it suggests that the company earns more on its operating assets than its borrowing costs. Sainsburys earned a negative spread in 2009 - as (RNOA<NBC). From previous analysis, 2009 stands out as a poor year for both retailers - especially in the case of Sainsburys. The implication of a negative spread to Sainsburys was a higher cost of borrowing as their operating income could not cover its financial liabilities. The manager at Sainsburys exceeded the optimum point for borrowing where (RNOA = NBC). Meaning close attention was not being paid as to when to stop borrowing - resulted in high gearing in 2009. Sainsburys could have stopped borrowings and concentrate on increasing operating income. Operating Liability Leverage - Overall Tesco proclaimed a higher average OLLEV ratio in comparison to Sainsburys. This simply could be due to the fact that Tesco are a bigger group and generate more revenue and therefore more operating liabilities. Tescos OLLEV seems to continue growing over the four years. While, j Sainsburys OLLEV are falling after its peak in 2009. Tescos higher OLLEV seems as though its not of concern as its generating more revenue each year to cover its operating liability. However while analysing the cash flow statement (the bar chart on the right), there was decrease in cash in two years and a subsequent increase in 2010 & 2011. Tesco might have found it rather difficult to pay the liabilities falling due in 2008 and 2009 because of a
'M

O--EV (200) * 2011)


0.80 0.*0
(%)

0.40 0.20 0.00 2008 200+ 2010 2011 Year #es&o 2 3ains4ury5s

/"2rea&e/3e2rea&e !" Ca&% (200) * 2011)


4000 3000 2000 1000 0 .1000 .2000 2008 200+ Year& 2010 2011 #es&o 2 3ains4ury

loss on cash. Sainsburys OLLEV peak in 2009 was partly due to a gradual increase in Trade and other payables and a lower NOA figure. Sainsburys also experienced a steady sales growth, however in three out of the four year period delivered a decrease in cash. In this case, it seems like good news that their OLLEV is falling. But if it falls too much, it might impact adversely on sales.
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"nalysis of &re(it *tatus #+t!er Performan,e Ratios$


Along with the profitability ratio and its break-down, I will utilise other commonly well known credit ratios to evaluate the performance of my chosen company (Tesco's) and its fierce competitor (J Sainsburys).
Ratio analysis for TESCO PLC:

Cre !t $tat4& Ra5o& Cre6itors 7ays 3to&8 #urno$er 7ays Current Ra o 0to 11 9ui&8 Ra o 0to 11 7e4tors 7ays :nterest Co$er 0 mes1 ;ross ro!t "argin0<1 Cas= %'o- to Assets0<1 Cas= %'o- to 3a'es0<1
Ratio analysis for J Sainsbury's:

2008

2009

2010

2011

*0.82 20.31 0.*1 0.38 10.12 11.4* 7.*7 12.27 7.83

*2.08 1+.44 0.78 0.*3 12.08 *.+4 7.7* +.+4 8.43

*5.8+ 1+.04 0.73 0.5* 12.11 *.03 8.10 11.*2 +.40

*8.4+ 20.** 0.*7 0.4+ 13.8* 8.01 8.30 +.50 7.3*

Cre !t $tat4& Ra5o& Cre6itors 7ays 3to&8 #urno$er 7ays Current Ra o 0to 11 9ui&8 Ra o 0to 11 7e4tors 7ays :nterest Co$er 0 mes1 ;ross ro!t "argin0<1 Cas= %'o- to Assets0<1 Cas= %'o- to 3a'es0<1

2008

2009

2010

2011

4+.43 14.7* 0.** 0.40 4.22 4.02 5.*2 8.+* 5.08

50.80 14.07 0.55 0.31 3.7* 4.55 5.48 10.13 5.38

47.*7 13.57 0.** 0.41 3.+3 4.80 5.42 10.07 5.47

47.53 14.8* 0.58 0.31 5.+3 7.34 5.50 8.35 4.51

Debtors Days - On average, Sainsburys has a much shorter debtors days in comparison to Tesco and the industry average (11.48 days). The impact of a shorter debtors days would mean a more healthy cash flow for J Sainsburys. However, less sales on credit for Sainsburys customers thus; this strategy may have limited additional potential revenues that could have been gained. While in the case of Tesco seems to be offering more sales on credit to customers should lead to improvements in revenue, but could also increase the likelihood of bad debts. The strategy based on how much sales credit is offered depends on both retailers management (cash flow to sales ratio is the closest to reveal an insight into this). Over the four year period, debtors days for Sainsburys seem rather stable, while Tescos ratio continues to rise steadily. Reason for the rise could be due high levels of unemployment during economic downturn and offering more credit sales to attract more these type of customers. Creditors Days - Sainsburys has lower creditors days compared to Tesco over the four year period. This isnt much of a surprise as Tesco are the market leader, price setters and have the ability to obtain large economies of scale, hence obtaining better payment terms with suppliers. Tesco can be seen to have a much higher bargaining power than that of its competitors. As these days increases over the four years, the better cash flow is expected to be. Tesco are taking longer to pay its suppliers than J Sainsburys. Tesco have succeeded in maintaining good relationship with its suppliers as stated in its mission statement, in order to improve their chances of maintaining better contracts from suppliers (Clark, 2010). Sainsburys have a similar believe in maintaining closer relationship with its suppliers, but this is not reflected from this ratio. Because over the four years creditors days seems to be decreasing.
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"nalysis of &re(it *tatus #&ont'($


Current Ratio - Looking at the charts, in general Tesco and Sainsburys are not holding enough current assets in order to cover their current obligations. Tescos current ratio are higher on average (0.7:1), compared to Sainsburys (0.61:1) &
Rat!o

...average stood at 0.31:1.

,e&2o (C4rre"t 6 74!28 Rat!o)


1.00 0.80 0.*0 0.40 0.20 0.00 2008 200+ 2010 2011 Year& Current Ratio0to 11 9ui&8 Ratio0to 11

industry (0.6:1 - Year 2011). Sainsburys current ratio looks to be fluctuating over the four years, while Tescos ratio seems to increase in 2009 and starts to drop steadily again in 2010 & 2011. Again, in reference to 2009 it is thought to be a difficult year for all retailers in this industry. However, it attained the highest current ratio in comparison to all other years due to the fall in interest rate and in turn Tescos borrowings to increase cash held. This in turn increased current assets and in turn favoured the ratio. In addition, Tesco might have needed the cash in order to survive in the short-term during 2009. Because after 2009, the cash held by Tesco (Statement of Financial position) started to decline; having studied their statement of financial position, some of these cash were used for Investments. Quick Ratio - my calculation of quick ratio is the ability for the firm to survive excluding stock. Also this ratio gives an insight as to how reliant the retailers are on stock. Once again by looking at the illustrations, Tesco seems to rely more on stocks in 2008 in comparison to other years. Through a deeper analysis, Sainsburys relied on stock the most in 2011 and relied less on stock in 2009 - as the difference between the current ratio and quick ratio revealed this insight. It comes as no surprise that in 2011, thats when cash held by Sainsburys was at its lowest over the four year period. Does this suggest confidence from Sainsburys in their stocks to sell within one year, and projected prediction for better revenue in years to come? I personally think this is true as the economy gets better. However, in 2011 industry...
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9 $a!"&:4r# (C4rre"t 6 74!28 Rat!o)


0.70 0.*0 0.50
Rat!o

0.40 0.30 0.20 0.10 0.00 2008 200+ Year 2010 2011 Current Ratio0to 11 9ui&8 Ratio0to 11

Stock Turnover - Sainsburys has a much lower stock turnover days than Tesco and the industry average (23 days) - both averaging at 14 and 20 days respectively. Both retailers did better than industry average. Tesco took six days longer to replenish its inventory, compared to J Sainsburys. This is mainly due to the fact that Tesco holds more stocks than Sainsburys as they expect more demand, therefore takes longer to sell. Both retailer ratios seems rather steady. This is the case, if other functions of the organisation (such as marketing) have done their market research well enough to know how much demand they are expecting, in order to be able to hold the right amount of stocks they are able to sell. However, if these stocks are piled up as demand has been wrongly forecasted, costs can be incurred to the retailers - i.e. storage costs. Both retailer seems to have succeeded to a certain degree in forecasting the demands for its goods. Because over the four year period stocks are increasing for both retailers and the ratio remains fairly constant.
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"nalysis of &re(it *tatus #&ont'($


Interest Cover - Tesco had a higher interest cover than Sainsburys in each year over the four year period. In 2008 Tesco had a high
Co;er (,!(e&)

/"tere&t Co;er (200) * 2011)


14.00 12.00 10.00 8.00 *.00 4.00 2.00 0.00 2008 200+ 2010 2011 Year&

twelve times interest cover. In 2010 Tesco ratio fell due to higher finance costs (579m), this must have been due to the increased in borrowings in 2009 (refer to borrowing chart in previous pages). It makes sense for the ratio to be adversely affected, especially if the borrowings in 2009 was a short-term borrowing (< 1 year) and it falls due in 2010. If this ratio was part of the determinants in dividends policy by Tesco directors in this particular year; hypothetically ordinary shareholders are less likely to receive

#es&o 3ains4ury5s

$*, Borro<!"=& (200) * 2011)


200 150
('M)

dividends - but dividends was actually received. Sainsburys had a lower interest cover rate compared to Tesco simply because Tesco had a higher Operating Income before Interest. In 2011, the Interest Cover ratio for Sainsburys was at its highest over the four year period because the finance cost was at its lowest over the four year period. One reason is because Sainsburys reduced its short-term borrowings in years 2010 & 2011 dramatically. It is unclear as

100 50 0 2008 200+ 2010 2011 Year& 3ains4ury5s

1ro&& Prof!t Mar=!" (%)


10.00 8.00
(%)

to why this strategy was implemented, even when interest rate was still low (0.5%). More positively, Operating income before interest increased during 2011.

*.00 4.00 2.00 0.00 2008 200+ Year& 2010 2011 #es&o 3ains4urys

Gross Profit - The rate of return for every 100 of sales. Tescos Gross profit kept improving over the four year period and out-performed the industry average of 6.85, mainly because of increasing turnover - even when cost of sales continued to rise. However, this is not the case for Sainsburys. They experienced a falling gross profit margin ratio in years 2009 & 2010. Although revenue improved gradually over the these period, the rate at which cost of sales was increasing was faster than the rate in which revenue was increasing. This adversely impacted on the ratio. In the fourth year Sainsbury performed below the industry benchmark The fall in gross profit shows that maybe Sainsburys are not bargaining for the lowest costs when purchasing from suppliers or they were not willing to switch to a more cheaper supplier.
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"nalysis of &re(it *tatus #&ont'($


The reason was because the rate of inflation in Cash flow to sales measures the proportion of cash from operatthe UK from 2008 to 2009 fell from 3.2% to ing activities to sales. Using this ratio, it gives a slight insight 2.2% (BBC News, 2013). This is expected to into the cash sales offered by each retailer. Tesco experienced an deliver a lower cost of sales in proportion to improvement in this ratio during the first three years, and a desales, but instead the gross profit margin de- cline in 2011. The main reason was due to the fact that there was clined. Furthermore, Inflation rate in 2011 rose to a decrease in cash from operations during 2011, even when reve4.5%, this is expected to adversely affect the nue continued to grow. We can conclude to an extent Tesco ofGross profit ratio, but instead gross profit im- fered more credit sales during 2011, which has impacted the cash proved during this year in comparison to previ- from operations. To fully conclude on the specific cause of the ous years (2009 & 2010). This should be further ratio, Tesco credit sales policy to customers needs to be scrutiinvestigated, as it illustrates some inconsisten- nised in depth to bring some other facts to light. Sainsburys cash flow to sales ratio similarly followed Tescos Cash flow to Assets measures the efficiency of ratio trend. Although revenue improved over the years, cash from the retailers. How well each company use their operations decreased. Tesco and Sainsburys could have both assets in producing cash from operating activities used this strategy (more credit sales) to attain more revenue. This ratio for Tesco was very unstable over the Tesco performed above the industry average of 5.66, while Sainsfour year period. This is affected through the burys this ratio. buying and selling of fixed assets in responds to growing cash from operating activities in years 2008, 2009 & 2010. Tesco were very efficient in 2008. However, in 2011 where total assets was at the highest over the four year period, the ratio fell to its lowest. This indicates inefficiency from Tesco during this year, as less cash from operations were produced in comparison to 2010, even when there was more assets. Sainsburys ratios likewise were quite volatile over the four year period, with it being least efficient in year 2011. Although there were more assets, Sainsburys achieved less cash from operations in comparison to year 2009 & 2010. In these years (2009 & 2010) they were more efficient compared to 2011.
'M
('M)

Ca&% fro( Operat!"= +2t!;!t!e& (200) * 2011)


*000 5000 4000 3000 2000 1000 0 2008 200+ Year& 2010 2011

#es&o 3ains4ury5s

,O,+- +$$E, (200) * 2011)


50000 40000 30000 20000 10000 0 2008 200+ 2010 2011 Year& #es&o 3ains4ury5s

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Fore,asting an( *!are Pri,e Valuation


This aim of this second section is to be able to calculate Tescos forecasted value of equity per share at the end of the fourth year (2011). Through this I am able to give my own opinions based on the calculated value of Tesco and thus advice my clients as to their next course of action - Buy, Hold or Sell Tesco shares. I believe that the Residual Earnings model was the best choice in valuing the share price of Tesco Plc as the share price valuation derived from this formula will be compared to actual share price of Tesco as at 26th February 2011. During this process, I utilised the use of the Compound Annual Growth Rate (CAGR) model. I chose this model in forecasting year 2012 Revenue, as it incorporates growth rate changes from year to year throughout the four year period and eliminates and smoothen volatile rate changes (by providing a rate as a result). Beginning value = 2008 Revenue figure & Ending value = 2011 Revenue figure. The rate that was derived (6.54%) from the CAGR formula was multiplied by the revenue for 2011 to obtain my revenue prediction (64,916m). However, the revenue prediction does not include much macroeconomic information and the calculation was based on past data. I found a way to incorporate analysts revenue figures before I arrive at my final Revenue. Analyst are specialists in the monitoring companies and experts in finance field and they would have take numerous accounts of macro economical information the CAGR model hasnt taken into consideration. Therefore, I worked out an average between four figures that includes the three individual analyst revenue figures along with the CAGR model revenue prediction (64,916m) - this resulted in my final Revenue (65,773m) that takes account of CAGR and macroeconomic factors. Below explains the process behind my theory. C+1R Mo e> Rate Year 2011 Re;e"4e C+1R Mo e> Re;e"4e +"a>#&t Re;e"4e& @niCre6it C=ar'es 3tan'ey E$o'u on 3e&uri es ?!"a> +;era=e Re;e"4e *.54< >*0?+31 >*4?+1*

>*4?+43 >*7?500 >*5?734 '6@A773

CAGR Formula - INVESTOPIDIA a, 2012

My predicted Revenue was surprisingly close to the actual 2012 Revenue. The next process was to be able to calculate the cost of equity as this will be needed for the calculation of Tescos share price through the Residual Earnings m o d e l . I obtained twenty-four years worth of Tesco share price and FTSE ALL SHARE Price Index. I calculated returns from the price indexes for both Tesco and FTSE ALL SHARE from DataStream. This enabled me to draw a regression analysis and to be able to obtain Beta (Appendix 1.3).
Coefficients Intercept X Variable 1 0.005649666 0.709382196 Standard Error 0.00317605 0.063222352 t Stat 1.778834 11.22043 P-value 0.076325 1.82E-24 Lower 95% -0.000601639 0.58494391 Upper 95% 0.011901 0.83382 Lower 95.0% -0.0006 0.584944 Upper 95.0% 0.011901 0.83382

From the result analysis Summary Output, the figure that is circled is the BETA and this was used with CAPM to calculate the Cost of Equity Beta measures the sensitivity of Tescos stock in relative to market changes. From this figure (0.709) - Tesco is not very sensitive to changes in the market environment, this truly reflects the company.
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Fore,asting an( *!are Pri,e Valuation #&ont'($


CAPM is a model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. (Investopidia b, 2012).

Calculation: cost of equity, ke

CA "

RA 0gi$en1 4.20<

equity 4eta

"8t ris8 premium 0.054*

equit 4eta / "8t ris8 premium 0.0387322*8

0.70+3821+*

ke

8.07<

The Risk-free rate is the returns on treasury bills in the UK in 2011. The Beta measures the sensitivity of a stock (Tesco shares) in relative to market conditions. Through this method, I was able to obtain Cost of Equity (Ke) 8.07% The common size analysis was used in conjunction with my final forecasted average Revenue and all the analysts forecasted Revenue figure in order to forecast year 2012E (Appendix 3.2), as some of these figures will be used in the Residual Earnings model (Appendix 2.1 -Trend & common size analysis).

All the components have been gathered and the Residual Earnings can now be used to calculate the share price.

Charles Stanley - believes that sales will be rather flat in 2012E due to food price inflation and sales growth will be around 2%. In addition, they believe that competitors behave more rational, evidenced from the returns they are delivering to their shareholders. This is all reflected in Charles Stanleys projected revenue forecast. They initiated a BUY advice at a target price of 411p. UniCredit - Similarly recommended a BUY advice at a target price of 454p. This analyst seems more certain that the value of Tesco will rise and it is currently been undervalued. Tescos 2012E revenue was forecasted at a much higher figure compared to Charles Stanley. This is justified through the believe that as the increases of services in the UK, it gives Tesco a huge advantage over its competitors. Moreover, due to the new CEO promises of better marketing strategy is at go. Evolutions Securities - In contrary to the other analysts advice, Evolutions Securities recommended a SELL advice to its clients at a price target of 375p. After the examination of competitors (i.e. Sainsburys and Asda) space war actions in their plans to expand, this analyst believe that food share is at risk been taken away from Tesco. In addition, the flaws that has been realised in Tescos strategy and competitors are hungry for more shares - as Tesco loses.

Volume 1, Issue 1

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Fore,asting an( *!are Pri,e Valuation #&ont'($


Residual Earnings (RE) Model 2011 (m) E2012 (m) Reform.Income statement Operating income Net financial expenses Comprehensive income (included the amount for MI) 2757.04 2976.1 3008.80 251.76 3255.06 278.96 E2012 (m) (C.S) E2012 (m) (U.C) E2012 (m) (E.S)

3340.51 28*.28 3054.23

3213.+7 275.44 2+38.53

3253.12 278.7+ 2+74.33

Reform. Balance Sheet Net operating assets Net financial obligations Ordinary shareholders' equity (included MI) 25884.00 9261.00

1**23.00

Residual Earnings (R-E)

1634.6

1712.8

1597.1

1632.9

Case 1: Assume that RE after 2012 would be zero because of strong competition in the industry. Intrinsic value of Tesco's equity in 2011 Intrinsic per share value ('s) Intrinsic P/B Intrinsic P/E

18135.5* 2.25 1.0+ *.58

18207.8* 2.2* 1.10 *.*0

18100.80 2.25 1.0+ *.57

18133.+2 2.25 1.0+ *.58

Case 2: if it assumes that REs after 2012 will remain as R-E forever. Intrinsic value of Tesco's equity in 2011 Intrinsic per share value ('s) Intrinsic P/B Intrinsic P/E

3*878.5*
4.58

3784*.72
4.70

3*413.01
4.53

3*85*.*3
4.58

2.22 13.38

2.28 13.73

2.1+ 13.21

2.22 13.37

Case 3: I have assumed a growth in RE after 2012 of 0.7%, to keep in line with 2011 GDP Intrinsic value of BT's equity in 2011 Intrinsic per share value ('s) Intrinsic P/B Intrinsic P/E
Volume 1, Issue 1

38802.43 4.82

39862.54 4.95

38292.66 4.76

38778.41 4.82

2.33 14.07
ID: 1032971

2.40 14.4*

2.30 13.8+

2.33 14.07
Page 13

Fore,asting an( *!are Pri,e Valuation #&ont'($


The model theorises three different scenarios in calculating the share price of Tesco. For each scenario I obtained four different share price valuation as there were four different estimate - my own, UniCredit, Charles Stanley and Evolution securities. I calculated it in this manner in order to draw a clear conclusion.

Judging from the output of the model based on Scenario 2; share price prediction value ranges from 4.53p - 4.70p. Based on scenario 3 however; share price prediction value ranges from 4.76p - 4.95p. As at 26th February 2011, Tescos actual share price stood at 4.061p.

*ummary
In conclusion
this illustrates that the market has jointly UNDERVALUED the share price of Tesco . The Residual Earnings model calculation appreciated the share price by around 19.55% (Using average of 4.76p & 4.95p = 4.855p). Target price should be 485.5p. Because of this reason I would advice my clients to BUY Tescos shares. Although, other competitors such as ASDA, Morrison's and Sainsburys are becoming more rational and competitive in this retail industry. Tesco are still market leaders and most of the examined analysts have provided no evidence that the share will decline in the foreseeable future - continuously growing revenue. Furthermore, their historic past performance has shown that they are a company with bright future, as most of their ratios continues to improve and remain favourable. Other Main Points

We believe Tescos current share price is cheap and undervalued. Huge opportunity for future growth in sales and ROCE in an international context Cost of equity is 7.33%. Both are quite low considering the downturn in the financial market. Cash investment of subsidiaries and capital expenditures shows positive future prospects. Free cash flow have improved dramatically as a result of extra borrowings to fund cash investments.

Volume 1, Issue 1

ID: 1032971

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"PP./D&I.*
APPENDIX 1.1 - TESCOS SWOT ANALYSIS (Adopted from MarketLine/DataMonitor)

STRENGTHS
Sustainable business model through diversification and value oriented retailing

WEAKNESSES
Losing customers to competitors

SWOT

Focus on developing non-food categories Complementing retailing services

OPPORTUNITIES
Strong growth in Chinese, Indian and Thailand markets provide long term growth prospects Growing use of online channel for making purchases Strong private label portfolio enables the company to effectively differentiate

THREATS
Restrictive legislations and strong lash out from the communities is limiting expansion opportunities Restrictive legislations and strong lash out from the communities is limiting expansion opportunities Demographic factors and change in consumer shopping preferences leading to decline in customer traffic at hypermarkets

APPENDIX 1.2 - Asset Turn Over drivers for Tesco & J Sainsburys
Ratios (Level 3) Asset Turnover (ATO) Drivers: 2008 2009 2010 2011

TESCO PLC

PPE Turnover Inventory Turnover Accounts Receivable Turnover Other Assets Turnover Accounts Payable Turnover Other Liability Turnover 1/+,O
Ratios (Level 3)

0.42 0.05 0.03 0.12 0.15 0.05 0.41


2008

0.43 0.05 0.03 0.2* 0.1* 0.14 0.47


2009

0.43 0.05 0.03 0.24 0.17 0.15 0.44


2010

0.40 0.05 0.04 0.25 0.17 0.14 0.42

J SAINSBURYS

2011

+&&et ,4r"o;er (+,O) 3r!;er&B E #urno$er :n$entory #urno$er A&&ount Re&ei$a4'e #urno$er Ot=er Asset #urno$er A&&ount aya4'e #urno$er Ot=er (ia4i'i es #urno$er 1/+,O 0.42 0.04 0.01 0.0+ 0.13 0.04 0.40 0.41 0.04 0.01 0.0* 0.13 0.04 0.35 0.41 0.04 0.01 0.08 0.12 0.05 0.3* 0.42 0.04 0.02 0.0* 0.12 0.04 0.3*

Volume 1, Issue 1

ID: 1032971

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"PP./D&I.* #,ont'($
APPENDIX 1.3 - Industry Average Credit Analysis as at 26th/Feb/2011 (Thomson One Banker)

Industry Benchmark Ratio analysis :

Cre !t $tat4& Ra5o& 3to&8 #urno$er 7ays Current Ra o 0to 11 9ui&8 Ra o 0to 11 7e4tors 7ays ;ross ro!t "argin0<1 Cas= %'o- to 3a'es0<1

2011

23.00 0.*0 0.31 11.48 *.85 5.**

Volume 1, Issue 1

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APPENDCIES (contd)
APPENDIX 2.1 - Trend & Common Size Analysis TREND AND COMMOM SIZE ANALYSIS 2008 m Operating Income
Revenue Cost of sales Administrative Expenses

2008 m 100

2009 m

2009 m 114.86

2010 m

2010 m 120.32

2011 m

2011 m 128.82

-0.92 -0.02 -0.94 99.06 -0.01 0.00 0.00 -0.01 0.06

92.24 -2.30 -94.53 5.47 -1.45 0.12 -0.19 -1.52 5.47

91.90 -2.68 -94.59 5.41 -1.48 0.19 -0.15 -1.45 5.41

91.70 -2.75 -94.45 5.55 -1.42 0.20 -0.15 -1.37 5.55

Operating Income from Sales (before tax)


Tax on Ordinary Activities Tax on Other Income Tax on Financial Items Total Operating Tax

Operating Income from Sales (After tax) Other Operating Income (before tax)
Profit arising from Property-related items Less: Tax Loss from operating activities Share of post-tax profits of joint ventures and assosiates

0.00 0.00

0.43 -0.12

0.66 -0.19

0.70 -0.20

Other Operating Income (After tax) Dirty Surplus Items of Operating activities
Foreign currency translation differences Total gain/Loss on defined benefit pension scheme Tax relating to Components of other C.Income Tax on item taken directly to equity Total Other operating Income

0.00 0.00

0.20 0.51

0.06 0.53

0.09 0.60

0.00 0.00 0.00 0.00 0.01 0.07

-0.51 -1.16 0.00 0.80 -0.35 5.12

0.60 -0.57 0.09 0.00 0.67 6.08

-0.56 0.98 -0.25 0 0.76 6.31

Operating Income Less: Financial Expense


Finance cost Finance Income Less: Tax

-0.01 0.00 0.00 0.00

0.00

-0.88 0.21 -0.67 0.19

-0.48

-1.02 0.47 -0.55 0.15

-0.40

-0.79 0.25 -0.55 0.15

-0.39

Dirty Surplus Items of Financing activities


Change/Loss on revaluation of available-for-sale investments Reclassified and reported in Group Income Statement Fair value Movements of Cash flow hedges

-8E05 0.00 0.00

Minority Interest Comprehensive Income to shareholders

0.00 0.05 0.00 0.05

0.01 -0.61 0.93

0.32 3.44 0.00 3.44

0.00 0.01 -0.30

-0.28 3.95 -0.05 3.90

0.00 0.01 -0.04

-0.02 4.52 -0.02 4.51

APPENDCIES (contd)
APPENDIX 2.2a - Tescos Reformulated Statement of Financial Position

TESCO PLC REFORMULATED GROUP BALANCE SHEET


2008 2008 m m Operating Assets (OA) Goodwill and other Intangible Assets Property, Plant and Equipment Investment Property Investment in Joint Ventures and Associates Other Investments Deferred tax assets Inventories Trade and Other Receivables Current Tax Assets Non-current assets classified as held for sale Non-Current Loans and Advances to customers Current Loans and Advances to customers Current Loans and Advances to banks and other financial assets Cash Flow Hedges Net Investment Hedges Cash Less: Operating Liabilities (OL) Trade and other payables Customer Deposits Current Tax liabilities Non-current Provision Current Provision 2336 19787 1112 305 4 104 2430 1311 6 308 19 2 1542 2009 2009 m m 4027 23152 1539 62 259 21 2669 1798 9 398 1470 1918 2129 102 92 2112 41757 2010 2010 m m 4177 24203 1731 152 863 38 2729 1888 6 373 1844 2268 144 148 19 2062 42645 2011 2011 m m 4338 24398 1863 316 1108 48 3162 2314 4 431 2127 2514 404 134 19 1785 44965

29266

7277 455 23 4

8522 4538 362 67 10

9442 4357 472 172 39

10484 5074 432 113 64

Post-employment benefit Obligation Deferred tax Liabilities Deposits by banks Cash Flow Hedges (2012 - Plus Net Investment Hedges) Net Investment Hedges Other non-current payables Net Operating Assets (NOA) Financial Assets (FA) Short-term Investments Fair Value Hedges Financial Instrument not qualifying for hedge accounting Cash and Cash equivalents Less: Financial Obligations Borrowings: amount falling due within 1 year Borrowings: amount falling due after more than 1 year Liabilities of the disposal group classified as held for sale Fair Value Hedges Financial Instrument not qualifying for hedge accounting Net Financial Obligation (NFO) Common Shareholders' Equity (CSE)

838 802 10 415 42

9866 19400

1494 696 24 90 361 68 16232 25525

1840 795 30 260 307 17714 24931

1356 1094 36 225 203 19081 25884

360 254 38 246

898

1233 1451 215 1397

4296

1314 1140 167 757

3378

1022 744 390 85

2241

2084 5972 80 260 8396 7498 11902

4059 12391 107 269 16826 12530 12995

1529 11744 133 222 13628 10250 14681

1386 9689 85 342 11502 9261 16623

APPENDIX 2.2b - J Sainsburys Reformulated Statement of Financial Position

SAINSBURY'S REFORMATED GROUP BALANCE SHEET FOR THE PERIODS 2009- 2012
2008 2008 2009 2009 2010 2010 2011 2011 m m m m m m m m Operating Assets (OA) Property Plant and Machinery Intangible Assets Investment in Joint Venture Other Receivables Retirement Benefit Assets Inventories Non-current assets held for sale Trade and Other Receivables Cash and cash equivalents Less: Operating Liabilities (OL) Trade and other payables Current Provisions Non-current Provisions Taxes Payable Other Payables Deferred income tax liability Retirement benefit obligation Net Operating Assets(NOA) Financial Assets (FA) Available for Sales Non-current derivative financial instruments 7424 165 148 55 495 681 112 206 719 7821 160 288 45 689 21 195 627 8203 144 449 36 702 56 215 837 8784 151 502 36 812 13 343 501

10005

9846

10642

11142

2280 10 63 191 89 321 -

2954 7051

2488 19 57 202 92 95 309

3262 6584

2466 13 66 200 106 144 421

3416 7226

2597 11 62 201 120 172 340

3503 7639

106 -

97 31

150 20

176 29

Current derivative financial instruments

4 110 7161

59 187 6771 56 8 154 2177

43 213 7439 41 2 73 2357

52 257 7896 59 2473 2260 4966 74 2339 2472 2215 5424

Less: Financial Obligations (FO) Current Derivatives Financial Instrument liabilities Non-Current Derivatives Financial Instrument liabilities Borrowings: amount falling due within 1 year Borrowings: amount falling due after more than 1 year Net Financial Obligations (NFO) Non- Controlling Interest (NCI) Common Shareholders' Equity (CSE)

6 18 118 2084

2226 2116 4935

2395 2208 4376

APPENDIX 2.3a - Tescos Reformulated Cash flow Statement

TESCO'S REFORMATED CASHFLOW STATEMENT FOR THE PERIODS 2008- 2011


2008 m Cash from Operating Activities ( C )
Cash generated from operations Corporation Tax paid Tax on Interest Dividend Received Effect of foreign exchange rate changes

2008 m

2009 m 4978 -456 133.104 589.10 69 120

2009 m

2010 m 5947

2010 m

2011 m 5366

2011 m

4099 346 84.6 430.6 88 -55 3701.4 3701.4

-512 -760 170.52 682.52 136.08 896.08 35 62 4577.90 49 5348.48 -46 4485.92 4577.90 5348.48 4485.92

Cash Investments (I)


Acquistion of Subsidiaries Proceeds from sale of joint ventures and associates Proceeds from sale of subsidiary Purchase of PPE and Investment Property Proceeds from sale of PPE Proceeds from Sale of Intangible Asset Purchase of intangible assets Increase in loans to joint ventures Decrease in loans to joint ventures Invested in joint ventures and associates

-169 3442 1056 -158 -36 -61 -2810 891.4

-1275 -4487 994 -220 -242 -30 -5260 -682.10

-65 -2855 1820 4 -163 -45 -4 -1308 4040.48 -

-89

-3178 1906 3 -373 -219 -25 -174

Free CashFlow C - I

-2149 2336.92

Financial Flow to Claimants (F)


Investments in short-term investments Proceeds from sale of short-term Investments Interest Paid Interest Received

360 410 128 282 84.6 197.4 9333 7593 -119 32 746 -523.6 -523.6 562 -90 472

1233 -360 690

1918 -1233 614

1264 -1314

Tax On Interest

-133.10 338.90 -7387 2733 18 1721 1703.104 1703.104

-81 609 170.52 438.48 -862 3601 41 -690 3213.48 3213.48

-128 486 136.08 349.92 -2175 4153 42 -949 1370.92 1370.92

Increase in borrowings Repayments of Borrowing New Finance Leases Repayments of Obligations under Finance Leases Increase/Decrease in Cash

Total Debt Financing Equity Financing (d)


Ordinary shares issued for cash Proceeds from sale of ordinary share capital to minority interests Dividends Paid Dividends Paid to Minority Interest Own Shares Purchased Other Adjustments

-138 -16 792 2 775 1415 891.4

-130 883 3 265 1021 -682.10

-167 968 2 24 827 4040.48

-98 1081 2 31 1016 2386.92

Total Equity Financing Total Financing Flow (F+d)

APPENDIX 2.3b - J Sainsburys Reformulated Cash flow Statement

SAINSBURY'S REFORMATED CASHFLOW STATEMENT FOR THE PERIODS 2008- 2011


2008 2008 m m Cash from Operating Activities ( C )
Cash generated from operations Corporation Tax paid Tax on Interest Dividend Received

2009 m 1206 -160 -32.43 -192.43 3 m

2009 m

2010 m 1206 -89 -26.04 -115.04 2

2010 m

2011 m 1138 -158 -28.89 -186.89 1

2011

998 -64 -28.2 -92.2 -

905.8 905.8

1016.57 1016.57

1092.96 1092.96

952.11 952.11

Cash Investments (I)


Acquistion of and investment in Subsidiaries Purchase of PPE Proceeds from disposal of PPE & other Assets Proceeds from Sale of Intangible Asset Purchase of intangible assets Invested in joint ventures and associates Cost of disposal of Operations

-7 -973 198 -6 -31 -1

Free CashFlow C - I Financial Flow to Claimants (F)


Interest Paid Interest Received Tax On Interest Investment in Financial Assets Repayments of Long-term Borrowing

-820 85.8

-10 -966 390 -10 -291 -

-1036 139 -11 -2 -887 129.57 -910 182.96 -

-1 -1136 282 -15 -2 -872 80.11

123 -29 94 -28.2

65.8 36

128 -13 115 -32.43

82.57 8 30

111 -18 93 -26.04

66.96 10 74

126 -19 107 -28.89

78.11 50 61

Interest elements of Obligations under Finance Leases payments Repayment of capital element of obligations under finance lease payment Proceeds from Long-term borrowing Proceeds from Short-term borrowing Repayments of Short-term Borrowing Increase/Decrease in Cash

3 -164

3 -152 -43 -2

3 2 -235 36 235

4 3 -45 11 -334

Total Debt Financing Equity Financing (d)


Proceeds from Issuance of ordinary shares Dividends Paid Capital Redemtion

-59.2 -59.2

-73.43 -73.43

191.96 191.96

-171.89 -171.89

-43 178 10 145 85.8

-15 218 203 129.57

-250 241 -9 182.96

-17 269 252 80.11

Total Equity Financing Total Financing Flow (F+d)

APPENDIX 3.1a - Tescos Reformulated Income Statement

TESCO'S REFORMATED INCOME STATEMENT FOR THE PERIODS 2008 - 2011


2008 m Operating Income
Revenue Cost of sales Administrative Expenses

2008 m 47298

2009 m

2009 m 54327

2010 m

2010 m 56910

2011 m

2011 m 60931

43668 -1027 44695 2603 -673 56.4 -18.9 -635.5 1967.5

-50109 -1248 -51357 2970 -788 66.55 102.08 -823.53 2146.47

-52303 -1527 -53830 3080 -840 105.56 -87.92 -822.36 2257.64

55871 -1676 -57547 3384 -864 119.56 -93.24 -837.68 2546.32

Operating Income from Sales (before tax)


Tax on Ordinary Activities Tax on Other Income Tax on Financial Items Total Operating Tax

Operating Income from Sales (After tax) Other Operating Income (before tax)
Profit arising from Property-related items Less: Tax Loss from operating activities Share of post-tax profits of joint ventures and assosiates

188 -56.4 75 206.6

236 -66.55 110 279.45

377 105.56 33 304.44

427 119.56 57 364.44

Other Operating Income (After tax) Dirty Surplus Items of Operating activities
Foreign currency translation differences Total gain/Loss on defined benefit pension scheme

38 187

-275 -629

343 -322

-344 595

Tax relating to Components of other C.Income Tax on item taken directly to equity Total Other operating Income

54 123 554.6 2522.1 435 -189.55 1956.92 379.44 2637.08

-153 462.44 3008.76

Operating Income Less: Financial Expense


Finance cost Finance Income Less: Tax

-250 187 -63 18.9

-44.1

-478 116 -362 102.08

-259.92

-579 265 -314 87.92

-226.08

-483 150 -333 93.24

-239.76

Dirty Surplus Items of Financing activities


Change/Loss on revaluation of available-for-sale investments Reclassified and reported in Group Income Statement Fair value Movements of Cash flow hedges

-4 -29 66

33 2511 -11 2500

3 -334 505

174 1871 -1 1870

1 5 -168

-162 2249 -27 2222

2 8 -22

-12 2757 -11 2746

Total Comprehensive Income Minority Interest Comprehensive Income to ordinary shareholders

APPENDIX 3.1b - J Sainsburys Reformulated Income Statement

SAINSBURYS REFORMATED INCOME STATEMENT FOR THE PERIODS 2008 - 2011


2008 m Operating Income
Revenue Cost of sales Administrative Expenses

2008 m 17837

2009 m

2009 m 18911

2010 m

2010 m 19964

2011 m

2011 m 21102

16835 -502 -150 9 -14.7 -155.7 344.3 30 -9 -2 19 542 -151 754.3 -132 83 -49 17337 500

-17875 -420 -177 16.074 -27.072 -187.998 428.002 57 -16.074 -111 -70.074 -903 253 -292.072 -148 52 -96 -18295 616

18882 -399 -148 7.56 -32.2 -172.64 510.36 27 -7.56 138 157.44 -173 48 542.8 -148 33 -115 -19281 683

19942 -417 -187 30.24 -23.52 -180.28 562.72 108 -30.24 60 137.76 29 -3 726.48 -116 32 -84 -20359 743

Operating Income from Sales (before tax)


Tax on Ordinary Activities Tax on Other Income Tax on Financial Items Total Operating Tax

Operating Income from Sales (After tax) Other Operating Income (before tax)
Other Income Less: Tax Share of Post-Tax loss from Joint Ventures

Other Operating Income (After tax) Dirty Surplus Items of Operating Activities
Actuarial gains on defined benefit pension schemes Less Tax impact on above item

Operating Income Less: Financing expense (income):


Finance expense Finance Income

Less: Tax benefit

14.7 -34.3 -31 48 2 -58 -10 -1

27.072 -68.928 -16 9 -32 -84.3 670 670 4 -103.928 -396 -396

32.2 -82.8 43 24 -3 -11

23.52 -60.48 14 2 -8 2 -29.8 513 513 -3 -53.48 673 673

Dirty Surplus Items of Financial Activities:


Available-for-sale financial assets:Group Available-for-sale financial assets:Joint ventures Cash flow hedge: Group Cash flow hedge: Joint Venture Sharebased payment Less: Tax on the above components of other comprehensive income

Total Comprehensive Income(to Ordinary Shareholders)

APPENDIX 3.2 - Analysts Forecasts & My Predicted Forecast & Actual 2012 Results

TESCO'S REFORMATED INCOME STATEMENT FOR THE PERIODS 2008 - 2011


Forcasting Based on Common Size Analysis and Analyst's Forecast: Evolution Securities UniCredit Charles Stanley LTD PLC 2012E 2012E 2012E 2012E 2012E 2012E m m m m m m Operating Income
Revenue Cost of sales Administrative Expenses

My Prediction 2012E 2012E m m 65773.22 60311.10 -1809.19

REAL OUTCOMES 2012 2012 m m 64539 59278 -1652

64943 59549.82 -1786.36 61336.18 3606.82 -920.89 118.33 -92.28 -894.84 2711.98 -957.15 122.99 -95.91 61894.48 -1856.69

67500 60275.14 -1808.11 63751.17 3748.83 -932.11 119.77 -93.40 -930.07 2818.76

65734

Operating Income from Sales (before tax)


Tax on Ordinary Activities Tax on Other Income Tax on Financial Items Total Operating Tax

62083.25 3650.75 -932.66 119.84 -93.46 -905.74 2745.01

62120.29 3652.93 -879 97.76 -62.66 -906.28 2746.65

-60930 3609

Operating Income from Sales (After tax) Other Operating Income (before tax)
Profit arising from Property-related items Less: Tax Loss from operating activities Share of post-tax profits of joint ventures and assosiates

-843.9 2765.1

455.12 -118.33 60.75 397.54

473.04 -122.99 63.15 413.19

460.66 -119.77 61.49 402.38

460.93 -119.84 61.53 402.62

Other Operating Income (After tax) Dirty Surplus Items of Operating activities

376 -97.76 -142 91 227.24

Foreign currency translation differences Total gain/Loss on defined benefit pension scheme Tax relating to Components of other C.Income Tax on item taken directly to equity Total Other operating Income

-366.65 634.18 -163.07 501.99 3213.97

-381.09 659.15 -169.50 521.76 3340.51

-371.12 641.90 -165.06 508.11 3253.12

-371.34 642.28 -165.16 508.41 3255.06

-22 -498 73 -219.76 2545.34

Operating Income Less: Financial Expense


Finance cost Finance Income Less: Tax

-514.80 159.88 -354.93 92.28

-262.65

-535.07 166.17 -368.90 95.91

-272.99

-521.07 161.82 -359.25 93.40

-265.84

-521.38 161.92 -359.46 93.46

-266.00

-417 176 -241 62.66

-178.34

Dirty Surplus Items of Financing activities


Change/Loss on revaluation of available-for-sale investments Reclassified and reported in Group Income Statement Fair value Movements of Cash flow hedges

2.13 8.53 -23.45

-12.79 2938.53 -11.72 2926.81

2.22 8.86 -24.37

-13.29 3054.23 -12.19 3042.05

2.16 8.63 -23.73

-12.95 2974.33 -11.87 2962.46

2.16 8.64 -23.75

-12.95 2976.10 -11.87 2964.23

13 -142 241

112 2479 -13 2466

Total Comprehensive Income Minority Interest Comprehensive Income to ordinary shareholders

APPENDCIES (contd)
APPENDIX 3.3a - 24 years historic Share prices, Index and Returns for TESCO & FTSE ALL SHARES (from DataStream)

Start End
Frequency Name Code CURRENCY 26/01/1987 26/02/1987 26/03/1987 26/04/1987 26/05/1987 26/06/1987 26/07/1987 26/08/1987 26/09/1987 26/10/1987 26/11/1987 26/12/1987 26/01/1988 26/02/1988 26/03/1988 26/04/1988 26/05/1988 26/06/1988 26/07/1988 26/08/1988 26/09/1988 26/10/1988 26/11/1988 26/12/1988 26/01/1989 26/02/1989 26/03/1989 26/04/1989 26/05/1989 26/06/1989 26/07/1989 26/08/1989 26/09/1989 26/10/1989 26/11/1989 M

26/01/1987 26/02/2011
TESCO - PRICE LNGBP
900803(P.LNGBP) 45.5 49.7 51.75 52.08 55.96 61.24 64.37 58.87 63.4 51.75 53.37 52.08 51.11 49.17 50.14 50.46 47.87 50.14 46.25 45.93 43.34 44.96 42.7 41.73 49.17 49.49 49.65 56.28 56.93 59.84 62.1 69.54 68.25 60.49 60.16

FTSE ALL SHARE PRICE INDEX


FTALLSH 889.93 982.89 1019.4 1001.3 1076.79 1151.76 1192.66 1145.3 1195.42 863.73 834.64 895.12 904.39 907.47 909.64 926.12 923.87 967.61 958.2 921.68 927.61 963.02 934.36 915.52 1010.7 1050.47 1068.68 1078.39 1103.81 1114.48 1158.37 1212.11 1186.44 1075.51 1114 RETURNS RETURNS (FTALLSH)

0.092308 0.041247 0.006377 0.074501 0.094353 0.05111 -0.08544 0.076949 -0.18375 0.031304 -0.02417 -0.01863 -0.03796 0.019727 0.006382 -0.05133 0.04742 -0.07758 -0.00692 -0.05639 0.037379 -0.05027 -0.02272 0.178289 0.006508 0.003233 0.133535 0.011549 0.051115 0.037767 0.119807 -0.01855 -0.1137 -0.00546

0.104458 0.037146 -0.01776 0.075392 0.069624 0.035511 -0.03971 0.043761 -0.27747 -0.03368 0.072462 0.010356 0.003406 0.002391 0.018117 -0.00243 0.047344 -0.00972 -0.03811 0.006434 0.038173 -0.02976 -0.02016 0.103963 0.039349 0.017335 0.009086 0.023572 0.009667 0.039382 0.046393 -0.02118 -0.0935 0.035788

26/12/1989 26/01/1990 26/02/1990 26/03/1990 26/04/1990 26/05/1990 26/06/1990 26/07/1990 26/08/1990 26/09/1990 26/10/1990 26/11/1990 26/12/1990 26/01/1991 26/02/1991 26/03/1991 26/04/1991 26/05/1991 26/06/1991 26/07/1991 26/08/1991 26/09/1991 26/10/1991 26/11/1991 26/12/1991 26/01/1992 26/02/1992 26/03/1992 26/04/1992 26/05/1992 26/06/1992 26/07/1992 26/08/1992 26/09/1992 26/10/1992 26/11/1992 26/12/1992 26/01/1993 26/02/1993 26/03/1993 26/04/1993 26/05/1993 26/06/1993 26/07/1993 26/08/1993 26/09/1993 26/10/1993

62.43 63.72 64.37 65.18 64.04 70.51 73.42 76.34 71.16 71.48 74.07 74.72 74.4 79.25 82 89.33 91 93.33 87.83 91.67 90.67 82.67 77.33 75 71 80.17 89.33 85.33 97.67 87.67 92 83.33 74 72.67 80 82.67 86.67 89.67 78.33 79 75 71 71.67 68.33 76.67 67.33 73.5

1177.11 1158.48 1118.85 1134.34 1060.85 1120.03 1181.1 1154.8 1018.83 966.97 997.77 1035.23 1036.52 1006.76 1123.31 1185.32 1197.4 1192.72 1170.72 1235.92 1264.73 1257.16 1216.26 1192.58 1142.61 1200.51 1228.94 1185.64 1275.75 1314.03 1224.17 1138.01 1087.44 1228.23 1256.9 1297.56 1355.18 1373.49 1396.53 1398.13 1392.17 1406.5 1425.65 1409.55 1527.83 1494.49 1564.82

0.037733 0.020663 0.010201 0.012584 -0.01749 0.101031 0.041271 0.039771 -0.06785 0.004497 0.036234 0.008775 -0.00428 0.065188 0.0347 0.08939 0.018695 0.025604 -0.05893 0.043721 -0.01091 -0.08823 -0.06459 -0.03013 -0.05333 0.129155 0.114257 -0.04478 0.144615 -0.10239 0.04939 -0.09424 -0.11196 -0.01797 0.100867 0.033375 0.048385 0.034614 -0.12646 0.008554 -0.05063 -0.05333 0.009437 -0.0466 0.122055 -0.12182 0.091638

0.056652 -0.01583 -0.03421 0.013845 -0.06479 0.055785 0.054525 -0.02227 -0.11774 -0.0509 0.031852 0.037544 0.001246 -0.02871 0.115767 0.055203 0.010191 -0.00391 -0.01845 0.055692 0.023311 -0.00599 -0.03253 -0.01947 -0.0419 0.050673 0.023682 -0.03523 0.076001 0.030006 -0.06839 -0.07038 -0.04444 0.129469 0.023343 0.032349 0.044406 0.013511 0.016775 0.001146 -0.00426 0.010293 0.013615 -0.01129 0.083913 -0.02182 0.04706

26/11/1993 26/12/1993 26/01/1994 26/02/1994 26/03/1994 26/04/1994 26/05/1994 26/06/1994 26/07/1994 26/08/1994 26/09/1994 26/10/1994 26/11/1994 26/12/1994 26/01/1995 26/02/1995 26/03/1995 26/04/1995 26/05/1995 26/06/1995 26/07/1995 26/08/1995 26/09/1995 26/10/1995 26/11/1995 26/12/1995 26/01/1996 26/02/1996 26/03/1996 26/04/1996 26/05/1996 26/06/1996 26/07/1996 26/08/1996 26/09/1996 26/10/1996 26/11/1996 26/12/1996 26/01/1997 26/02/1997 26/03/1997 26/04/1997 26/05/1997 26/06/1997 26/07/1997 26/08/1997 26/09/1997

65.33 70.67 76.67 74.5 70.83 68 71.67 75 78.83 84.5 76 77.33 81 81.33 84.67 84 87.67 91.83 95.83 93.67 104.67 112.33 106.33 102 95.33 98 98.5 89.33 90.67 94.33 99.33 98.67 95.67 103.83 101.33 108 112 118.33 120 115 114.33 121.33 125.33 124 144.33 139.83 162.83

1533.3 1677.01 1723.99 1654.67 1581.24 1579.75 1524.54 1445.85 1557.85 1630.33 1505.22 1496.6 1509.03 1526.37 1489.05 1500.15 1541.81 1580.39 1628.35 1625.33 1698.31 1735.64 1737.86 1730.57 1772.82 1788.21 1829.35 1830.26 1826.17 1921.09 1885.87 1853.24 1824.11 1930.75 1939.2 1973.9 1988.83 2000.54 2066.62 2115.81 2094.89 2112.15 2216.7 2206.71 2273.55 2306.04 2445.86

-0.11116 0.081739 0.084902 -0.0283 -0.04926 -0.03995 0.053971 0.046463 0.051067 0.071927 -0.10059 0.0175 0.047459 0.004074 0.041067 -0.00791 0.04369 0.047451 0.043559 -0.02254 0.117434 0.073182 -0.05341 -0.04072 -0.06539 0.028008 0.005102 -0.0931 0.015001 0.040366 0.053005 -0.00664 -0.0304 0.085293 -0.02408 0.065825 0.037037 0.056518 0.014113 -0.04167 -0.00583 0.061226 0.032968 -0.01061 0.163952 -0.03118 0.164485

-0.02014 0.093726 0.028014 -0.04021 -0.04438 -0.00094 -0.03495 -0.05162 0.077463 0.046526 -0.07674 -0.00573 0.008305 0.011491 -0.02445 0.007454 0.027771 0.025023 0.030347 -0.00185 0.044902 0.021981 0.001279 -0.00419 0.024414 0.008681 0.023006 0.000497 -0.00223 0.051978 -0.01833 -0.0173 -0.01572 0.058461 0.004377 0.017894 0.007564 0.005888 0.033031 0.023802 -0.00989 0.008239 0.049499 -0.00451 0.030289 0.01429 0.060632

26/10/1997 26/11/1997 26/12/1997 26/01/1998 26/02/1998 26/03/1998 26/04/1998 26/05/1998 26/06/1998 26/07/1998 26/08/1998 26/09/1998 26/10/1998 26/11/1998 26/12/1998 26/01/1999 26/02/1999 26/03/1999 26/04/1999 26/05/1999 26/06/1999 26/07/1999 26/08/1999 26/09/1999 26/10/1999 26/11/1999 26/12/1999 26/01/2000 26/02/2000 26/03/2000 26/04/2000 26/05/2000 26/06/2000 26/07/2000 26/08/2000 26/09/2000 26/10/2000 26/11/2000 26/12/2000 26/01/2001 26/02/2001 26/03/2001 26/04/2001 26/05/2001 26/06/2001 26/07/2001 26/08/2001

158.67 159.33 161.17 174.33 174 192.33 184.33 188.33 192.67 191 159 163.5 161.25 180.25 171 177.25 177 169 190.75 172.75 166.75 163.25 178 179.5 180.75 175 187 162.75 169 197.75 217.5 206.25 208.25 218 220 239.75 262.75 275 276 251 263.5 251 251.25 241 265 238 260

2361.32 2308.9 2358.07 2451 2675.64 2771.33 2764.67 2841.04 2762 2760.92 2576.02 2343.85 2413.62 2660.89 2663.74 2676.66 2825.39 2835.04 3003.72 2894.77 2990.6 2900.9 2992.59 2789.94 2837.05 3119.07 3189.42 3027.96 2975.05 3195.29 2973.36 2954.55 3064.26 3072.15 3154.07 2999.23 3018.36 3029.55 2927.44 3027.15 2867.1 2683.31 2821.75 2852.69 2692.05 2556.71 2645.93

-0.02555 0.00416 0.011548 0.081653 -0.00189 0.105345 -0.0416 0.0217 0.023045 -0.00867 -0.16754 0.028302 -0.01376 0.117829 -0.05132 0.03655 -0.00141 -0.0452 0.128698 -0.09436 -0.03473 -0.02099 0.090352 0.008427 0.006964 -0.03181 0.068571 -0.12968 0.038402 0.170118 0.099874 -0.05172 0.009697 0.046819 0.009174 0.089773 0.095933 0.046622 0.003636 -0.09058 0.049801 -0.04744 0.000996 -0.0408 0.099585 -0.10189 0.092437

-0.03456 -0.0222 0.021296 0.039409 0.091652 0.035763 -0.0024 0.027624 -0.02782 -0.00039 -0.06697 -0.09013 0.029767 0.102448 0.001071 0.00485 0.055566 0.003415 0.059498 -0.03627 0.033105 -0.02999 0.031607 -0.06772 0.016886 0.099406 0.022555 -0.05062 -0.01747 0.074029 -0.06946 -0.00633 0.037133 0.002575 0.026665 -0.04909 0.006378 0.003707 -0.0337 0.03406 -0.05287 -0.0641 0.051593 0.010965 -0.05631 -0.05027 0.034896

26/09/2001 26/10/2001 26/11/2001 26/12/2001 26/01/2002 26/02/2002 26/03/2002 26/04/2002 26/05/2002 26/06/2002 26/07/2002 26/08/2002 26/09/2002 26/10/2002 26/11/2002 26/12/2002 26/01/2003 26/02/2003 26/03/2003 26/04/2003 26/05/2003 26/06/2003 26/07/2003 26/08/2003 26/09/2003 26/10/2003 26/11/2003 26/12/2003 26/01/2004 26/02/2004 26/03/2004 26/04/2004 26/05/2004 26/06/2004 26/07/2004 26/08/2004 26/09/2004 26/10/2004 26/11/2004 26/12/2004 26/01/2005 26/02/2005 26/03/2005 26/04/2005 26/05/2005 26/06/2005 26/07/2005

245 244.25 244.5 247.5 235.25 246 242.25 262.75 254 238 205.25 219.25 204 204.5 194.5 190.25 178 159.5 187.25 194 201.75 217.25 218 214 241 235 248.5 249.25 242.5 253.75 248.75 255 250 269.75 251.5 267 286 285.5 305.5 319.5 306 308.5 316.75 310 314.5 316 315

2251.61 2481.68 2561.31 2502.13 2511.73 2480.03 2522.2 2509.4 2514.04 2206.42 1947.63 2120.19 1860.24 1942.05 1956.55 1893.09 1749.49 1731.5 1814.79 1863.06 1932.15 1973.89 2029.54 2069.36 2057.18 2100.15 2157.77 2190.98 2210.19 2252.33 2182.61 2280.32 2203.69 2238.29 2135.4 2211.06 2272.41 2278.21 2362.13 2400 2435.72 2510.72 2470.58 2428.05 2494.64 2544.34 2627.62

-0.05769 -0.00306 0.001024 0.01227 -0.04949 0.045696 -0.01524 0.084623 -0.0333 -0.06299 -0.13761 0.06821 -0.06956 0.002451 -0.0489 -0.02185 -0.06439 -0.10393 0.173981 0.036048 0.039948 0.076828 0.003452 -0.01835 0.126168 -0.0249 0.057447 0.003018 -0.02708 0.046392 -0.0197 0.025126 -0.01961 0.079 -0.06766 0.06163 0.071161 -0.00175 0.070053 0.045827 -0.04225 0.00817 0.026742 -0.02131 0.014516 0.004769 -0.00316

-0.14903 0.10218 0.032087 -0.02311 0.003837 -0.01262 0.017004 -0.00507 0.001849 -0.12236 -0.11729 0.0886 -0.12261 0.043978 0.007466 -0.03243 -0.07585 -0.01028 0.048103 0.026598 0.037084 0.021603 0.028193 0.01962 -0.00589 0.020888 0.027436 0.015391 0.008768 0.019066 -0.03095 0.044768 -0.0336 0.015701 -0.04597 0.035431 0.027747 0.002552 0.036836 0.016032 0.014883 0.030792 -0.01599 -0.01721 0.027425 0.019923 0.032731

26/08/2005 26/09/2005 26/10/2005 26/11/2005 26/12/2005 26/01/2006 26/02/2006 26/03/2006 26/04/2006 26/05/2006 26/06/2006 26/07/2006 26/08/2006 26/09/2006 26/10/2006 26/11/2006 26/12/2006 26/01/2007 26/02/2007 26/03/2007 26/04/2007 26/05/2007 26/06/2007 26/07/2007 26/08/2007 26/09/2007 26/10/2007 26/11/2007 26/12/2007 26/01/2008 26/02/2008 26/03/2008 26/04/2008 26/05/2008 26/06/2008 26/07/2008 26/08/2008 26/09/2008 26/10/2008 26/11/2008 26/12/2008 26/01/2009 26/02/2009 26/03/2009 26/04/2009 26/05/2009 26/06/2009

326.75 317.75 297.25 310 326.75 318.75 335.5 346 323 323 330 363.5 368 367 400.5 398 402.75 410.25 448 438.5 467.5 453.5 426.25 405.5 420 436.5 464.75 465 478 420.75 409.25 391.25 426.5 414 364.7 377.3 385 370.9 318 290.4 340.4 360.6 338.2 331.1 355.4 363.3 354.9

2627.58 2732.4 2623.01 2782.87 2835.12 2907.51 2986.44 3081.68 3114.54 2954.92 2891.56 2979.1 2990.21 3005.71 3168.27 3148.68 3203.05 3223.26 3336.16 3274.82 3364.52 3413.63 3384.04 3228.93 3209.46 3296.97 3421.31 3160.2 3292.18 2990.24 3113.58 2897.77 3097.2 3098.46 2808.24 2722.39 2786.12 2581.97 1950.15 2065.25 2111.37 2105.48 1970.18 1984.18 2127.37 2247.79 2167.29

0.037302 -0.02754 -0.06452 0.042893 0.054032 -0.02448 0.052549 0.031297 -0.06647 0 0.021672 0.101515 0.01238 -0.00272 0.091281 -0.00624 0.011935 0.018622 0.092017 -0.02121 0.066135 -0.02995 -0.06009 -0.04868 0.035758 0.039286 0.064719 0.000538 0.027957 -0.11977 -0.02733 -0.04398 0.090096 -0.02931 -0.11908 0.034549 0.020408 -0.03662 -0.14263 -0.08679 0.172176 0.059342 -0.06212 -0.02099 0.073392 0.022228 -0.02312

-1.5E-05 0.039892 -0.04003 0.060945 0.018776 0.025533 0.027147 0.031891 0.010663 -0.05125 -0.02144 0.030274 0.003729 0.005184 0.054084 -0.00618 0.017268 0.00631 0.035027 -0.01839 0.027391 0.014596 -0.00867 -0.04584 -0.00603 0.027266 0.037713 -0.07632 0.041763 -0.09171 0.041248 -0.06931 0.068822 0.000407 -0.09367 -0.03057 0.02341 -0.07327 -0.2447 0.059021 0.022331 -0.00279 -0.06426 0.007106 0.072166 0.056605 -0.03581

26/07/2009 26/08/2009 26/09/2009 26/10/2009 26/11/2009 26/12/2009 26/01/2010 26/02/2010 26/03/2010 26/04/2010 26/05/2010 26/06/2010 26/07/2010 26/08/2010 26/09/2010 26/10/2010 26/11/2010 26/12/2010 26/01/2011 26/02/2011

368.4 371.9 387.1 388 429.3 426.95 418.9 419.7 434.2 454.4 399 398.65 395.4 401.9 439 428.95 430 439 403 406.05

2336.39 2511.29 2608.38 2661.7 2648.56 2752.28 2700.86 2736.8 2922.85 2963.38 2598.08 2609.05 2762.54 2660.35 2889.12 2953.87 2930.78 3107.71 3096.38 3109.27

0.038039 0.009501 0.040871 0.002325 0.106443 -0.00547 -0.01885 0.00191 0.034548 0.046522 -0.12192 -0.00088 -0.00815 0.016439 0.092312 -0.02289 0.002448 0.02093 -0.082 0.007568

0.078024 0.074859 0.038661 0.020442 -0.00494 0.039161 -0.01868 0.013307 0.067981 0.013867 -0.12327 0.004222 0.05883 -0.03699 0.085992 0.022412 -0.00782 0.06037 -0.00365 0.004163

APPENDCIES (contd)
APPENDIX 3.3b - Regression Analysis

SUMMARY OUTPUT Regression Statistics Multiple R 0.552189547 R Square 0.304913295 Adjusted R Square 0.302491391 Standard Error 0.05365089 Observations 289 ANOVA df Regression Residual Total SS MS F 1 0.362387436 0.362387 125.8981 287 0.826105954 0.002878 288 1.188493391 Standard Error Significance F 1.81872E-24

Coefficients Intercept X Variable 1

t Stat

P-value

Lower 95%

Upper 95%

Lower 95.0%

Upper 95.0%

0.005649666 0.00317605 1.778834 0.076325 0.000601639 0.011901 0.00060164 0.01190097 0.709382196 0.063222352 11.22043 1.82E-24 0.58494391 0.8338205 0.58494391 0.83382048

Tesco
Upgrade to Buy
Company Note
TSCO.L
12m Range Net Debt Weight in Sector (350) Weight in Index (100) Basic Shares 455-368p 1.8bn 66.7% 2.1% 8,030m

403p
32.3bn
01 February 2011

UK FTSE 100 Food Retail

Missing the Point


Tescos share price has been weak in recent weeks, driven by a somewhat disappointing post-Christmas trading update. The episode has led some analysts to question future growth prospects for the core UK business, which accounted for c.67% of Group operating profit in 2009/10. In our opinion, however, the weak likefor-like sales performance can at least in part be attributed to bad weather in the UK, with December having been the coldest since modern records began in 1910. The structure of Tescos store portfolio and sales mix appears to have made it particularly vulnerable to weather related disruption. Going forward into 2011, likefor-like sales growth is likely to remain relatively subdued, but we would expect it to move back in line with the industry. The mature state of the UK food retail market and Tescos c.30% market share means we have expected profit growth in this part of the business to moderate for some time. Increasingly, we expect International and Retailing Services to take over as the drivers of earnings growth. The core UK food retailing business will act as the cash cow to fund growth in these areas. Underlying earnings growth could well slow from the low double-digit rate of recent years to high single-digit, but we think this is more than discounted in the current share price. The valuation (February 2012 PE 11.2x) looks too cheap for a company with such good long term defensive growth prospects and significant asset backing (NAV c.280p). We see potential for a total return from the shares in excess of 15% over the next 12 months. In line with our recommendation criteria, we upgrade from
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TESCO
460

1/2/11

440

420

400

380

360

340

320

300

280

260 F TESCO M A M J J A S O N D J F M A M J J A S O N D J

TSCO/FTALLSH Source: Thomson Datastream

Sam Hart
020 7149 6504 sam.hart@charles-stanley.co.uk

Accumulate to Buy (last comment was on 18 January 2011 at 411p).

Company Activities
Tesco is the worlds 3rd largest retailer, with 5,000 stores and 97m sq ft of space. In the UK, it is the leading food retailer, with 2,545 stores, 33m sq ft of space and a c30% market share. It operates through a range of retail formats, including hypermarkets (Extra), superstores, convenience (Metro / Express) and on-line (tesco.com). It also owns Dobbies Garden Centres. Tesco Bank has 6.5m customer accounts and offers a range of savings, insurance, loan and credit card products. Tesco Mobile has 2.3m mobile phone customers. Overseas, the Group has 1,300 stores (35m sq ft) in Asia and 1,000 stores (29m sq ft) in Europe. In the US, there are 165 Fresh & Easy stores (1.7m sq ft) following launch in November 2007. The Group has a 90% stake in dunnhumby, a global consumer insight business with data on 350m consumers.

UK Christmas trading. Like-for-like sales excluding fuel (but including VAT) in the six
th

weeks to 8 January were up by 0.6%, weaker than consensus expectations of +1.7% (source: Reuters). Adjusting for changes to the VAT rate, however, like-for-like sales are estimated to have been down by 0.3-0.4%. The performance represents the first period in which Tesco has reported negative like-for-like sales for c.20 years. Nonfood appears to have been the key area of weakness, impacted by bad weather which prevented customers travelling to larger out of town stores (greatest exposure to nonfood). Tesco is particularly vulnerable to weakness in non-food categories, given much higher exposure than peers. Non-food represents c.25% of UK sales, compared with c.15% for Sainsbury and c.8% at Morrison. The food category was said to have delivered a strong like-for-like sales performance. UK performance vs. peers. The Christmas trading performance was unquestionably behind the industry average, but perhaps not to the extent it appears at first sight. Sainsbury like-for-like sales excluding fuel (but including VAT) were up by 3.6% over
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the 14 weeks to 8 January, but this was boosted by a c.1% contribution from store extensions, 0.8% from the higher VAT rate and a strong performance from the nonfood range, which remains at a relatively early stage of development. Morrisons likend

for-like sales were up by c.2% in the six weeks to 2 January, but similarly benefited by c.0.9% from the higher VAT rate and remains in turnaround mode. UK like-for-like sales outlook. We expect like-for-like sales in the UK food retail industry to remain relatively subdued in 2011. The demand environment is likely to be
Year to February Sales (m) Pre-tax Profit (m) EPS (p) DPS (p) 2009A 53,898 2,917 27.0 12.0 14.9x 3.0% 2010A 56,910 3,176 29.2 13.1 13.8x 3.2% 2011E 62,450 3,500 32.5 14.5 12.4x 3.6% 2012E 67,500 3,950 35.8 16.0 11.2x 4.0% 2013E 72,500 4,350 40.0 17.9 10.1x 4.4%

Charles Stanley clients can access research at www.charles-stanley,co,uk Please refer to important disclaimers at end of document

PER Net Div Yield Source: Charles Stanley forecasts

Charles Stanley & Co. Limited does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity, independence and impartiality of this report. Investors should consider this report as only a single factor in making their investment decision. For important disclosures, refer to the back of this document or go to http://www.charles-stanley.co.uk/research/. This document is a marketing communication. This research has not been prepared in accordance with regulatory requirements designed to promote the independence of investment research.

Tesco 01 February 2011

constrained, with consumers under pressure from higher direct and indirect taxes, subinflation wage growth and concerns over future employment prospects amongst workers in the public sector. Underlying sales volumes are likely to be flat or in slightly negative territory. Food price inflation is therefore anticipated to be the main driver of like-for-like sales growth. Price inflation in the industry is currently believed to be in the 1.5-2.0% range and we would expect it to continue to tick up as commodity price increases continue to feed through to food prices. We forecast Tescos like-for-like sales growth (ex-fuel and VAT) to be c.2% in the 2011/12 fiscal year, broadly in line with managements planning assumptions. UK competitive environment is expected to remain intense but rational. Rational players. We believe the main players in the UK food retail industry are behaving rationally and expect them to continue to do so. Tesco, Sainsbury and Morrison all have to justify returns to shareholders. Initiation of a price war would be suicidal and lead to a collapse in profitability for all in the market. Perhaps the greatest threat comes from Asda, given that it is a division of the much larger Walmart and therefore has more limited disclosure requirements. We see no logical reason, however, why Walmart would want to initiate a price war and further reduce already disappointing returns from the business. Asdas latest 10% cheaper promise should be regarded as a marketing gimmick, rather than a sign of aggressive price reductions. Promotional activity is running at a historic high of 35-40% of industry sales (historic average 20-25% of sales). Such a high level of promotional participation is disruptive to supply chains and customer shopping habits. The impact on gross margins, however, is believed to be relatively limited, with a high proportion of promotions being funded by suppliers of branded goods eager to support volumes. New space. Total industry space is believed to have grown by c.6% in 2010 and is forecast to increase by a further c.4.5% in 2011. The rate of space expansion is well above the historic rate of 2-3% and has raised concerns that the market might be becoming saturated. We remain relatively sanguine, however, about the rate of new space expansion. Approximately 40% of all new space is being allocated to non-food and a further 20% to the convenience segment. The new space data also includes some recycled space, such as Asdas acquisition of 193 Netto stores and Tescos 77 Mills convenience stores. International is expected to become an increasingly important driver of profit growth. The profit contribution is currently being held back by heavy investment in a number of markets, but we expect it to increase as assets mature. We briefly remind investors of the Groups activities in its major overseas markets and future growth prospects.
th Europe (13% 2010 operating profit). As at 28 August 2010, the Group had 1,004 stores in Europe covering 28.8m sq ft of space. It operates in Poland, Hungary, the Czech Republic, Slovakia, the Republic of Ireland and Turkey, listed in descending order by space. The region was the worst hit by the global economic downturn, but firm evidence of recovery in sales and profits was seen in the interim results and the improving trend is expected to continue. Guidance is for total space to increase by 2.9m sq ft (+10%) in the 2010/11 fiscal year. Development of the business in Turkey (branded Kipa) is a key strategic priority, given its large, growing and relatively under-developed retail market.

Asia (12% 2010 operating profit). The Group has 1,300 stores in the region covering 32.8m sq ft of space. It operates in South Korea, Thailand, China, Malaysia and Japan, listed in descending order by total space. The region was relatively unaffected by the global economic downturn, meaning the business continued to deliver solid growth in sales and profits throughout. The trend is expected to continue, although profitability is likely to be held back by heavy investment. Guidance is for total space to increase by 3.7m sq ft (+12%) in 2010/11. Korea has proven to be the most successful market for Tesco to date and it is now joint market leader. China, however, has been identified as a significant opportunity for the future. Its current strategy in China is focused around building Lifespace shopping malls (as part of a JV) in second and third tier cities in the east of the country. The Group plans to build 80 malls in the 2010-15 period, of which three are currently open. The approach ensures that Tesco is the anchor tenant in the shopping malls and therefore guarantees high footfall locations for its stores. China is expected to breakeven in 2010/11, with operating profit potentially building to c.100m by 2015.

US (loss-making). Tesco entered the US in November 2007 with the opening of its first Fresh & Easy neighbourhood store. The format is almost unique in the US
Page 2 of 4

Equity Research

Company Report

Wholesale & Retail

United Kingdom

24 January 2011

Tesco
More room for maneuver than you think
Tesco's growth profile is changing as UK LFL normalizes. While we agree that using a historical rating is not appropriate given the change in profile, the resilience of the UK profit (thanks to services) deserves a re-rating in our view. We initiate coverage on Tesco with a Buy and a 454p target price, suggesting 11.5% upside.

Buy (prev. Coverage in transition)


Price on 21 Jan 2011 Target price (prev. n.a.) Upside to TP Cost of equity High/Low (12M) INVESTMENT HIGHLIGHTS Attractive valuation Lower long-term growth but better returns Visibility of the UK margin STOCK TRIGGERS FY results 19 April STOCK DATA

GBP 4.07 GBP 4.54


11.5% 7.5% 4.54/3.78

Tesco is not the growth company it used to be. UK LFL is normalizing as competitors improve. Things will remain tough in the UK as the impact of fiscal tightening as well as the increase in petrol prices hit consumers.

However, our analysis shows that Tesco, thanks to its services, can further reduce its UK retail margin without hitting UK total profitability. Our conservative forecasts imply a 30bp lower UK retail margin in 2013E vs. today.

Reuters/Bloomberg Average daily volume ('000) Free float (%) Market capitalization (GBP bn) No. of shares issued (mn)

TSCO.L/TSCO LN 16089.1 98.0 32.0 7637.1

Moreover, Philip Clarke, the incoming CEO, has recalled senior management from abroad to the UK. We believe Tesco is looking at ways to reignite its UK top-line growth. We may hear more on 19 April in connection with the full-year results.

Shareholders

3.02% Berkshire Hathaway Inc., 5.24% Blackrock Inc., 3.65% Legal & General Investment Management Limited

UPCOMING EVENTS FY10 results 19 Apr 2011 Jun 2011 Oct 2011

At the current share price, Tesco offers lower P/E than Metro or Casino for similar growth. We value Tesco on a DCF basis and derive a 454p target price. This would imply a 13x P/E 2011E calendarized 12M, which in our view appears justified.

1Q11 results 1H11 results


450 400 350 300

250

2009 Sales (GBP mn) yoy (%) Trading profit (GBP mn) margin (%) EPS reported (p) EPS diluted before non recurring and property (p) yoy (%) ROCE (%) P/E (x) P/CF (x) EV/Sales (%) EV/EBITDA (x) EV/EBIT (x) Div. yield (%) 54164 14.5 3090.0 5.7 27.50 25.19 -5.9 7.8 13.7 7.2 68.7 8.2 11.6 3.2

2010 56910 5.1 3412.0 6.0 29.33 27.34 8.5 7.4 13.9 6.9 68.8 8.1 11.4 3.1

2011E 60813 6.9 3688.4 6.1 34.38 30.71 12.3 7.8 11.9 7.6 62.5 7.2 10.0 3.5

2012E 64943 6.8 4055.4 6.2 37.39 34.68 12.9 8.1 10.4 6.8 55.5 6.3 8.6 3.8

2013E 69322 6.7 4457.1 6.3 41.14 38.46

200

150
TESCO EURO STOXX 50 - PRICE INDEX

2008

2009

2010
Source: Thomson Datastream

STOCK PERFORMANCE (% CHG.) 1M FTSE 100 -6.9 -10.4 -5.9 3M -10.2 -10.5 -4.7 6M -11.9 -9.2 -2.0

10.9 8.5 10.3 6.2 53.5 6.1 8.3 4.1

Euro STOXX 50 ES Retail

Fabienne Caron, Equity Analyst (UniCredit Bank London) +44 20 7826 7951 fabienne.caron@unicreditgroup.de Rupert Trotter, Marketing Analyst (UniCredit Bank London) +44 20 7826 7890 rupert.trotter@unicreditgroup.de

Source: Tesco, UniCredit Research estimates

UniCredit Research

page 1

See last pages for disclaimer.

24 January 2011

Equity Research

Tesco

Investment case / Valuation


We initiate on Tesco with a Buy rating and a 454p target price. We are aware that Tesco does not offer the growth it used to. However, in this note we highlight the increased room for maneuver in the UK as the impact of services increases gives Tesco a strong competitive advantage. Later in the report, we analyze the UK performance and highlight that 1) in 2010 Tesco stemmed its sales loss to competitors, particularly ASDA and Morrisons, 2) Tesco's change in customer traffic slowed in 2010 but was offset by customers spending more, and 3) impressively, Tesco continues to increase its household penetration. Finally we discuss the international business with a focus on Ireland, South Korea, Thailand, China and the US.

Not a good investment over the last two years


Tesco is rightly seen as the industry benchmark, given its impressive growth (UK organic sales growth close to 8% over the past decade), dominant market share in its home country (30%), as well as its state-of-the-art IT, logistics and loyalty card (the Tesco Club Card) and of course its very capable management team. However, Tesco has not made for a good investment over recent years given its lack of momentum in the UK as competitors catch up and Tesco LFL normalizes.

TESCO UNDERPERFORMED IN 2009 AND 2010

Tesco share price relative to FTSE 100 Annual relative performance vs FTSE 100 (RHS) 3.5 3 2.5 2 1.5 1 0.5 0 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 60% 50% 40% 30% 20% 10% 0% -10% -20%

Source: UniCredit Research

UniCredit Research

page 4

See last pages for disclaimer.

19 January 2011

Price/Target: Mkt Cap: Net Cash/(Debt) (FY1)

411p/375p 33bn -6,780m

Tesco

(TSCO.L)

Sell

Tesco Tuesday - Price Repositioning Needed


Tesco should reposition on UK pricing. Rolling industry trends forward sees Tesco lose strategic position, puts returns under pressure and sees the competition gain strength. A major repositioning would cost Tesco proportionately less than the competition (c10% of group profits vs c60% at Sainsbury), would hurt competitor's cash flows more and would bring an end to industry over expansion. The competition are happy with the status quo, so Tesco should do what the competition fear and act in the long term interests of all its stakeholders. It is rational for Tesco to do this, it has a new CEO and the macro environment is right. Tesco has a legacy of price repositionings coinciding with a change of management.

Feb PBT EPS (p) DPS (p) P/E (x)

2010A 3,131 27.6 13.1 14.9x

2011E 3,414 30.5 14.9 13.5x

2012E 3,868 34.8 16.0 11.8x

550 500 450 400 350 300 250 Jan 06 Jul 06 Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11
Source: FactSet Estimates

Price

Price Relative to FTSE 100

Rolling Forward: Tesco operates c36m. sq ft of space in the UK. In 5 years, at current expansion rates, Tesco would have over 46m sq ft, having invested an incremental 10bn+. The returns on this capex are questionable, cannibalisation will increase and public reaction to "Tescopoly" could be harmful. But Tesco cannot unilaterally stop opening space - it needs the competition to stop as well.

Status quo favours the competition: At current expansion rates Sainsbury space will rise to c26m sq ft (18m currently), ASDA will rise to c25m sq ft (from 19m)and Morrisons to c16m sq ft (12m now). Cannibalisation is not an issue for these retailers and collectively they are likely to take food share from Tesco. Stopping industry expansion suits Tesco: The current space war is costing the Big 4 over 4bn in capex pa, including c2bn for Tesco (see "Capital Wars" 3/11/2010). By lowering industry profits and cash flow, Tesco can make new stores unviable for the competition while protecting its own long term returns. Tesco can then curtail its UK openings and harvest cash flow to invest overseas. A repositioned UK Tesco could generate more cash post capex than now.

Will Tesco do it? We are not changing forecasts, but we are highlighting the crash to industry profits if Tesco repositions. We are also saying that the prospect of Tesco doing this is rising as performance deteriorates. Sector share prices would get hit very hard, but Tesco would emerge as a clear winner and its shares would rerate after the market had digested the implications of such a bold move.

Year End Feb Sales (m) EBITDA (m) EVO PBT (m) EPS (p) DPS (p) Growth PBT (%) Growth EPS (%) P/E (x) EV/Sales (x) EV/EBITDA (x) Yield (%) Dave McCarthy
+44 (0)20 7071 4715 dave.mccarthy@evosecurities.com

2009A 53,898 4,275 2,834 24.5 12.0 +3% +5% 16.8x 0.8x 13.3x 2.9%

2010A 56,911 4,796 3,131 27.6 13.1 +10% +13% 14.9x 0.7x 11.8x 3.2%

2011E 60,984 5,031 3,414 30.5 14.9 +9% +10% 13.5x 0.7x 10.5x 3.6%

2012E 65,734 5,543 3,868 34.8 16.0 +13% +14% 11.8x 0.6x 9.4x 3.9%

2013E 70,434 6,064 4,306 38.7 17.4 +11% +11% 10.6x 0.6x 8.6x 4.2%

Andrew Porteous
+44 (0)20 7071 4441 andrew.porteous@evosecurities.com

EVO Securities makes markets in Tesco This publication was produced by Evolution Securities Limited (ESL). This publication is disseminated in the EEA by ESL. This publication is disseminated in the US by Evolution Securities US (ESUS); it has not been altered in any way by ESUS prior to distribution. ESUS is a wholly owned subsidiary of ESL. Under the Markets in Financial Instruments Directive and the Financial Services Authoritys Conduct of Business Rules, this document is a marketing communication and has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although it is not subject to any legal requirement prohibiting dealing ahead of the dissemination of investment research, Evolution Securities Ltd upholds this standard through its internal systems and controls.

The company has reviewed a draft of this research note and factual changes have been made

REFERENCES
Arnold, g., 2012.Corporate Financial Management. 5thed.London : Pearson Education Limited BBC News (2013). Economy tracker: Interest rates. Available at: http://www.bbc.co.uk/news/business-11013715 [Accessed on 17th December 2012] Clark (2010) Tesco works to boost supplier relationships. Available at: http://www.supplymanagement.com/news/2010/tesco-works-to-boost-supplierrelationships/ [Accessed on 17th December 2012] Data Stream (2013).[e-library]. Available through University of Birmingham Library. Investopidia (2013) a. Compound annual Growth Rate CAGR. Available at: http://www.investopedia.com/terms/c/cagr.asp#axzz2I4Z3q2o7 [Accessed on 17th December 2012] Investopidia (2013) b. Capital Asset Pricing Model- CAPM. Available at: http://www.investopedia.com/terms/c/capm.asp#axzz2I4Z3q2o7 [Accessed on 17th December 2012] Market Line/ Data Monitor 360 (2013).[e-library]. Available through University of Birmingham Library Website:http://advantage.marketline.com.ezproxyd.bham.ac.uk/Product?pid=349724149A41-4048-A7B6-1B0017054743 Penman, Stephen.H.,2010. Financial Statement Analysis and Security Valuation. 4thed. New York: Mc Graw Hill Tesco (2013).Our Businesses. Available at:http://www.tescoplc.com/index.asp?pageid=8 [Accessed on 14th December 2012] J Sainsburys. Annual Report 2008-2012, London: Sainsburys Tesco, 2008. Annual Report 2008-2012, Hertfordshire: Tesco Thomson One Banker (2013). [e-library]. Available through University of Birmingham Library Website: http://banker.thomsonib.com.ezproxyd.bham.ac.uk/ta/?ExpressCode=Birmingham