UK retail giant Tesco booked a healthy set of results this week, despite facing fierce competition from rivals in recent months and experiencing a slowdown in international expansion. With such a strong set of figures under its belt, it’s clear Tesco is coping well in the downturn. Dean Best reports.
And so the Tesco juggernaut motors on. The UK retailer has come in for fierce criticism in recent months, with industry watchers claiming the company has been misfiring.
Tesco, they have argued, has taken its eye off the ball in the UK, where discounters Aldi and Lidl have gained in popularity during the downturn, and where close rivals Asda, Sainsbury’s and Morrisons have gained ground on the market leader.
What’s more, it has been said, Tesco’s much vaunted international operations, businesses held up as evidence of the robustness of the retailer’s long-term strategy, have struggled in the global economic headwinds.
And in the US, well, Tesco could hardly have embarked on such an ambitious venture at a worse time economically, its detractors have pointed out.
However, after the publication yesterday of a set of strong numbers from Tesco (pre-tax profits topped GBP3bn (US$4.39bn)), it’s clear Tesco is anything but misfiring.
The world’s third-largest retailer reported a 10% rise in annual underlying pre-tax profits, a significant achievement in these turbulent economic times. Tesco’s international sales rose by 13.3% at constant currencies as the company saw its growth in Asia accelerate on the back of the Homever acquisition in South Korea, a deal signed in last May and seen by some as pricey.
In the UK, like-for-like sales rose by 4.3%, slower growth than that seen at Asda, Sainsbury’s and Morrisons, but, as market leader, Tesco has always been vulnerable to rivals more keen to fight on price.
Richard Hunter, head of UK equities at stockbroker Hargreaves Lansdown, says the results should silence some of the critics.
“Tesco’s numbers should be enough to see off some more of its detractors, even though it has somewhat become a victim of its own success over recent times,” he says. “The 10% rise in profits in the current environment is no mean feat. Underlying sales were strong, there is a planned expenditure cut of GBP3.5bn pounds and the 10% hike in the dividend is proof of management confidence going forward.”
Tesco is also ramping up some of its non-food businesses in the UK, including banking and telecoms, moves that, according to Hunter, set the retailer apart from its domestic peers. “Some of Tesco’s UK supremacy has undoubtedly been eroded by rivals playing the value card, but few of those competitors have the diversified business mix which leaves the company well placed,” Hunter says.
That said, as the UK navigates the worst recession for at least a generation, Tesco faces some challenges. The launch of its Discount Brands by Tesco was seen by some as confusing for consumers. And, while chief executive Sir Terry Leahy claims shoppers “know absolutely what the discount range is all about”, some have viewed the launch of the range as evidence that Tesco misjudged the threat coming from its cut-price German rivals.
In the months ahead, Sir Terry said Tesco will still compete on price in the UK but the retailer appears to be placing less emphasis on that tactic with the imminent relaunch of its Clubcard scheme. The “quite major” investment is a move, the Tesco chief says, to rebuild loyalty among consumers who had shopped around as the downturn eroded confidence.
“It’s a big investment, there’s real money going in,” Sir Terry says. “Investing into Clubcard is a different way of rewarding consumers , which is better for the long-term. It’s better to go into Clubcard than encouraging high-low promiscuous shopping.”
The investment will come as Tesco also looks to expand its floor space in the UK and overseas. Capital expenditure will be lower than in the last fiscal year – reflecting the fact that Tesco’s debt grew from GBP6.2bn to GBP9.6bn over the last 12 months – but the retailer is still aiming to expand its selling space in the UK by 7% this year.
Internationally, Tesco has seen some encouraging signs despite the impact of the recession. In Central Europe, which Sir Terry says was among the regions hit the earliest by the downturn, Tesco saw its market share grow in each of the markets in which it operates year-on-year during the fourth quarter of its fiscal year.
In China, Tesco is looking to further expand its business, with shopping center development projects in the pipeline in three different regions. Shopping centers, says Sir Terry, are “the foundation of profitable retailing in China”.
The one squeaky wheel on the Tesco trolley is the retailer’s US venture. The company reported yesterday that losses from its Fresh & Easy business in the US had risen over the last fiscal year. Trading losses stood at GBP142m for the 12 months to 28 February, up from GBP62m a year earlier.
Tesco has decided to slow the pace of its expansion in the US, which has lead to its sales in the country being lower than forecast at GBP208m.
Nevertheless, Sir Terry says the weakness of the sterling had been a factor in the increased losses at Fresh & Easy. The Tesco boss insists establishing a business in the US had led to a series of “up-front” investments.
Nonetheless, Sir Terry admits that the downturn had meant Tesco was now opening “one or two stores a week” in the US, “a more rapid rate of growth than our competitors” but down from previous targets.
“I don’t have any regrets about the strategy but I have regrets about opening in a recession,” Sir Terry says, adding, however, that it had been impossible to predict when the downturn would hit the economy.
He says the problems in the US economy, including the growing number of foreclosures and rising unemployment, had meant populations had fallen in some parts of the western US, where Tesco has until now focused its business Stateside.
Sir Terry insists, however, that US consumers were taking to the Fresh & Easy business. “I’m very pleased with the promising start we’ve made. I see plenty of encouraging signs. [Consumers] understand the format.”
Industry watchers in the US, however, are more circumspect about the prospects for Fresh & Easy. Neil Stern, senior partner at US retail consultants McMillanDoolittle, says Tesco has changed elements of the business since it first opened and, while he says like-for-like sales are improving, the venture’s initial sales had set down “a very disappointing initial base”.
“It is fairly clear that the initial concept badly missed the mark on in-store experience, pricing and marketing strategies [but] these are all areas that have undergone significant change since opening,” Stern tells just-food.
Tesco says manufacturers in the US may have misunderstood the concept of Fresh & Easy and the retailer is now in talks about changing pack sizes and price points to better reflect the chain’s ambition to be a “one-stop shop”.
However, Stern believes the confusion stems from Tesco’s lack of success in communicating to its suppliers what it wants Fresh & Easy to be. There has been “a tremendous amount of confusion” about the venture’s positioning, Stern argues.
“It is not a convenience store, at all, but Tesco has used this in description of the concept. One stop shop is what they want to be but have done a poor job of explaining that to the world, [and] apparently [to] suppliers as well. However, I don’t believe that suppliers have missed the mark too badly,” Stern says.
Nonetheless, Stern insists Fresh & Easy still has long-term potential. “The bottom line is that the business is growing slower than they had hoped and losing more money, initially, than [Tesco] planned. But, this really needs to be looked at in a long-term perspective. If they get it right, the opportunity remains enormous.”
Given Tesco’s performance more broadly over the last 12 months in what is a very challenging market, it would be foolhardy to right off its foray into the US at this juncture.