Tesco's Capital Efficiency: A Sustainable Turnaround for the Retail Giant?

Tesco PLC (LSE: TSCO), the UK's largest grocery retailer, has long grappled with the challenges of a fragmented retail landscape and shifting consumer preferences. However, recent financial and operational developments suggest a potential reversal of fortunes. This article evaluates whether Tesco's improving capital efficiency-marked by rising ROCE and strategic CAPEX reallocation-signals a sustainable turnaround, supported by its growing emphasis on ESG (Environmental, Social, and Governance) initiatives.

Capital Efficiency: A Modest but Notable Uptrend

Tesco's Return on Capital Employed (ROCE) has steadily climbed from a median of 6.5% in 2021 to 9.2% in 2025, according to finbox.com. This improvement reflects better utilization of working capital and fixed assets, driven by cost discipline and operational streamlining. For instance, adjusted operating profit surged 12.8% in 2024 to £2,829 million, despite a 6.9% decline in 2023, as detailed in Tesco's 2023/24 annual report. Analysts attribute this resilience to tighter inventory management and a focus on high-margin private-label products.

However, the Return on Invested Capital (ROIC) tells a more nuanced story. As of June 2025, Tesco's ROIC stood at 5.16%, significantly below its Weighted Average Cost of Capital (WACC) of 8.23%, according to GuruFocus. This gap raises concerns about the company's ability to generate value for shareholders through capital allocation. While ROCE improvements suggest operational efficiency, the ROIC-WACC disparity indicates that reinvestment returns remain suboptimal.

CAPEX Reallocation: From Cost-Cutting to Strategic Sustainability

Tesco's capital expenditures (CAPEX) have trended downward, hitting a five-year low of £1.16 billion in 2023, per finbox CAPEX. This reduction initially sparked concerns about underinvestment, but the company has since redirected funds toward sustainability-linked projects. For example, Tesco signed the UK's largest corporate solar Power Purchase Agreement (PPA) for the Cleve Hill Solar Park, which will power 144 stores annually, as Supply Chain Digital reports. Such initiatives align with its 2035 net-zero operations target and demonstrate a shift from traditional CAPEX to long-term value creation.

Notably, 2025 CAPEX figures remain undisclosed, but the company's sustainability report highlights a 65% reduction in Scope 1 and 2 emissions since 2016/17, surpassing its 2025 target, according to Supply Chain Digital. These environmental gains are paired with social initiatives, such as redistributing 25,000 tonnes of surplus food in 2023/24-equivalent to 60 million meals-through partnerships with FareShare and OLIO, also reported by Supply Chain Digital. While these efforts bolster brand equity and regulatory compliance, their direct impact on capital efficiency remains quantitatively unproven.

ESG Integration: A Double-Edged Sword

Tesco's ESG strategy is ambitious but complex. The company aims to halve food waste by 2025 (baseline 2016/17) and achieve deforestation-free sourcing for key commodities by 2025, goals covered in Supply Chain Digital. These goals are financed partly through sustainability-linked bonds, which tie borrowing costs to emissions reduction progress, as IFAC explains. Such financial engineering could enhance long-term profitability by aligning capital costs with ESG performance.

Yet, ESG metrics alone cannot offset weak ROIC. For instance, while Tesco's renewable energy investments reduce energy costs, their upfront CAPEX may strain short-term returns. Similarly, food waste reduction programs, though socially laudable, require ongoing logistical investments. The challenge lies in balancing these initiatives with shareholder expectations for capital efficiency.

Sustainability of the Turnaround: Key Considerations

1. Operational Synergies: Tesco's ROCE gains suggest that cost-cutting and digital transformation (e.g., online grocery infrastructure) are paying off. However, sustaining these improvements will require continued innovation in logistics and supply chain management.
2. ESG ROI: While sustainability initiatives are critical for regulatory compliance and brand resilience, their financial returns must be quantified. For example, the Cleve Hill Solar Park is expected to lower energy costs over time, but the payback period remains undisclosed.
3. Market Dynamics: Tesco faces intensifying competition from discounters like Aldi and Lidl. Maintaining market share while investing in sustainability could strain margins unless productivity gains offset these costs.

Conclusion: A Cautious Optimism

Tesco's improving ROCE and strategic CAPEX reallocation indicate a credible, if modest, turnaround. However, the ROIC-WACC gap and reliance on ESG-linked financing underscore structural challenges. For investors, the key question is whether these initiatives will translate into durable profitability. While the company's sustainability efforts enhance long-term resilience, they must be paired with sharper capital allocation to ensure returns exceed costs.

As Tesco's 2025 annual report is published, stakeholders will scrutinize its ROIC trajectory and detailed CAPEX breakdowns for clarity. Until then, the jury remains out on whether this is a sustainable reversal of fortunes-or a temporary reprieve.