Shore Capital lifts forecasts at Tesco after strong Christmas trading

Shore Capital has nudged up forecasts for Tesco after a resilient 19-week trading update and a stronger-than-expected Christmas, with Tesco delivering 3.2% sales growth over the six-week festive period and continuing to gain market share. Management now expects adjusted operating profit at the upper end of the £2.9bn–£3.1bn range and ShoreCap raised full-year operating profit and earnings forecasts by around 3%, implying EPS of 28.4p this year and 31.0p next year; free cash flow guidance remains £1.4bn–£1.8bn. The broker reiterated a buy at 416p, citing steady profit growth, a c.3.5% dividend yield and ongoing buybacks, while flagging a competitive 2026 and uncertainty from easing inflation and potential behavioural effects of weight-loss drugs.

Analysis

MARKET STRUCTURE: Tesco (TSCO.L) is a clear near-term winner from the Christmas trading beat—gaining share versus peers (SBRY.L, OCDO.L) as customers trade within the grocery sector. The uplift suggests Tesco can sustain ~3% like-for-like sales outperformance through the festive/early-2026 period, supporting cash generation (£1.4–1.8bn FCF) and dividend/buyback finance. For suppliers, tilt toward fresh over processed goods would reweight demand toward perishable supply chains (dairy, produce) and away from packaged food manufacturers.

RISK ASSESSMENT: Key tails include rapid adoption of GLP‑1 weight‑loss drugs materially reducing grocery volumes (-3% to -7% vs. baseline over 2 years) and an aggressive price war compressing margins by >100bp. Immediate (days) risks: sentiment reversal on weaker UK CPI/food prints; short-term (weeks/months): competitor promotional cycles and margin volatility; long-term (quarters/years): structural volume decline or regulatory action on pricing. Hidden dependencies: Tesco’s buybacks amplify EPS sensitivity to FCF variance; a fall below £1.4bn FCF would force policy change and re-rating.

TRADE IMPLICATIONS: Establish a modest 2–3% long position in TSCO.L (buy up to 430p) with a 10% stop-loss and 12–18 month target of 480–520p if EPS reaches ~31p and buybacks continue. Pair trade: long TSCO.L vs short SBRY.L (size 1:1) to capture relative share gains; initiate within 2–6 weeks. Options: buy a 6-month bull‑call spread (buy 420p/520p) funded by selling 3-month covered calls to enhance yield; cap max loss to premium paid.

CONTRARIAN ANGLES: Consensus may underprice downside from GLP‑1 adoption and overprice Tesco on steady valuation—current re‑rating leaves limited multiple upside, so upside will be earnings-driven not multiple expansion. Mispricing risk: if Tesco’s FCF dips below £1.4bn or market share slips >1ppt, expect a >15% downside re-rating. Historical parallel: supermarkets post‑2008 deflation saw share moves concentrated by execution—operational delivery matters more than macro headlines.

Key Decisions for Investors

• Establish a 2–3% portfolio long position in Tesco (TSCO.L) at prices <=430p, target 480–520p over 12–18 months; set a stop-loss at 10% below entry (~<=387p) and reassess if free cash flow <£1.4bn or FY26 EPS <25p.
• Initiate a pair trade: long TSCO.L vs short Sainsbury's (SBRY.L) equal notional (size ~1–2% gross each) to capture Tesco’s market share momentum; exit or tighten if SBRY shrugs off promotions within 8–12 weeks or if Tesco market share gain reverses by >1 percentage point.
• Options strategy: buy a 6‑month bull call spread on TSCO.L (buy 420p call, sell 520p call) sized to represent 1–2% delta exposure, financed by selling 1–2 months covered calls around current yield to capture dividend; limit max capital at risk to 0.5–1% of portfolio.
• Reduce or avoid exposure to online/technology‑heavy grocery plays (e.g., OCDO.L) by 1–2% weight in favor of defensive staples until UK grocery volume trends and commodity price disinflation confirm recovery (monitor CPI food and industry volume data monthly; act within 60 days).
• Monitor three short‑term catalysts for tightening positions: UK food CPI (monthly), Tesco monthly market share reports (industry data) and FY26 interim trading updates; if any show adverse drift (food CPI rising >100bp month-on-month or Tesco market share loss >1ppt), cut longs by 50% within 5 trading days.