Can Tesco Recover?

Can Tesco bounce back from it’s worst results in a century?

Tesco's 2014-15 results are out on Wednesday, and after a series of scandals and bad headlines, they're expected to be very ugly. 

Pretty much every financial journalist and analyst is expecting a massacre.

The Financial Times suggested that the company may report an annual loss of up to £5 billion ($7.43 billion) on Wednesday, calling it "the worst performance in the near-100-year history of Britain’s biggest retailer".

But global investment banking giant HSBC is staying bullish. They've got a "buy" rating on Tesco shares and a target price of 295 pence. Since the shares are currently at 235.85 pence, if they're right that would be a big windfall for anyone buying now. 

As always, what's most important from an investment perspective is the trajectory — not just how the company did in the last year, but how it's going to do. 

Some think Tesco has improved notably under new CEO Dave Lewis, who came from Unilever and had barely begun in the job when the company was forced into an embarrassing £250 million profit restatement, and the full extent of the company's financial weakness became clear.

Despite that, Tesco has been catching up with the industry in terms of sales growth, after a period of massive under-performance, and it's now no longer losing significant market share:

What about the competition?

While Germany's ruthless discounting supermarkets are still hitting the headlines, Aldi and Lidl's actual effect on the market is becoming a bit more muted. From a peak about a year ago, sales growth at both firms seems to be slowing, and market share growth is too.

There are major advantages to the fact that Tesco is an absolutely massive business — with a market capitalisation of more than £19 billion and over 300,000 employees in the UK, the company has some significant advantages that simply come from its scale.

Here are three major scale advantages that underpin Tesco’s margin advantage - simply how much profit the company is making in comparison to sales, so a 300bp margin means profits which are 3% of revenues:

•  Buying power: For the same amount of turnover in terms of sales, Tesco's buying power offers it an advantage. If Sainsbury and Tesco both make £1 billion in sales, HSBC reckon all else being equal Tesco would make 0.3 percentage points more in terms of profit — and every little helps.

•  Fixed costs: Costs like advertising are more expensive for smaller companies if they want to match Tesco. They say Sainsbury would have to spend 0.45 percentage points of its total sales to match Tesco if the larger firm spent 0.25 percentage points of its total sales. Again, individually these don't break the bank, but in a margin-thin industry like retail, it accumulates and makes a difference.

•  Networks and logistics: This one is probably the simplest. With more employees, stores and pretty much everything else, distributing its goods around the country costs Tesco less per mile, or per pound earned. 

Even if the news is awful tomorrow, Tesco has the foundation to be a solid company for years to come.