Tesco’s decision to quit Japan is Philip Clarke’s first significant strategic move as CEO but the move has led industry watchers to wonder if the UK retailer could leave othe international markets, Dean Best writes.
It did not take Philip Clarke long to make his first serious mark as Tesco’s chief executive.
Of course, Clarke is a Tesco lifer, having taken a part-time job at the UK retailer in 1974, while still at school, and then moving up through the business to lead its international operations in 2003. Clarke can be credited, for example, for Tesco’s moves into China and South Korea.
However, on Wednesday (31 August), just five months after Clarke took the top job, he made his first significant strategic move as CEO – the decision to leave Japan.
Tesco made a move to enter the Japanese market in 2003, although that came three months before Clarke took on the responsibility for the retailer’s operations outside the UK. In June that year, Tesco announced a bid to buy local convenience retailer C Two-Network. In fact, the retailer had been studying how to expand into Japan since 2000 and then chief executive Terry Leahy said the acquisition of C Two-Network provided the UK firm with “an excellent opportunity to enter a large and unconsolidated market with potential for growth”. In 2004 and 2005, Tesco made two more, smaller acquisitions in Japan.
The early optimism, however, faded. Tesco’s like-for-like sales in Japan fell by more than 8% in the retailer’s last financial year, which ended on 26 February. In the last eighteen months, Tesco has recorded impairment costs of GBP186m on its Japanese business. Tesco does not publish EBIT figures for individual countries but, according to analysts at Barclays Capital, the retailer’s operations in Japan made a loss of around GBP11m in its most recent financial year. When Clarke took the Tesco hot seat in March, some analysts were already speculating that one of his first moves would be to take the retailer out of Japan.
One analyst was Clive Black at Shore Capital. Speaking to just-food today (2 September), Black hinted that the specific characteristics of the Japanese food sector meant Tesco was never able to build a profitable business. “Japan has significant structural barriers. Japan is still a very supplier-dominated market,” he said.
Analysts seemed to broadly welcome Tesco’s decision to leave Japan. RBS analyst Justin Scarborough called the move “unsurprising and sensible” and added: “It is another example of Phil Clarke being very much on the front foot in his quest to drive the Tesco business model harder and move returns higher.”
The decision meant thoughts naturally turned to some of Tesco’s other international divisions, with analysts focusing on the prospects for the retailer in China, Turkey and, notably and predictably, the US.
Fresh & Easy, Tesco’s US unit, has proved the retailer’s most contentious venture in recent years. The business has attracted a lot of criticism almost since the first Fresh & Easy store was opened. Some City analysts and US retail watchers have questioned the future of Fresh & Easy, a venture that no less than Warren Buffett has described as “foolhardy”. And concerns have grown in recent months, especially since Tesco revealed its US losses increased in its last financial year.
At the publication of Tesco’s annual results, Clarke said it was “essential” that Fresh & Easy’s losses fall this year but insisted he was confident the chain would be profitable by the end of the 2012/13 financial year.
However, Tesco’s exit from Japan has given some analysts the opportunity to again put forth their views on Fresh & Easy. MF Global analyst Mike Dennis, a long-time critic of Tesco’s moves in the US, said the company’s problems in Japan should have been a sign that it is difficult to set up a sizeable business in developed markets. Nevertheless, he argued that Tesco’s management had not learnt lessons from its experience in Japan.
“Tesco exiting Japan is not just a sign that financial discipline is coming to the forefront but also a realisation for them that building scalable businesses in highly developed markets is not easy. It has taken Tesco more than ten years to understand this and several acquisitions, format resets, asset write downs and the exit of several major high profile competitors. Tesco’s over-inflated self belief, some might say arrogance, cannot be allowed to make the same mistake in the US,” Dennis wrote this week.
“In the time Tesco took to acquire and open 62 stores (post the C2 acquisition) 7-11 had opened over 3,000 stores in Japan. Tesco knew all the market facts before entering the Japanese market yet believed there was a gap in the market. Despite this experience in Japan it seems Tesco does not seem to have learnt this lesson with its failed entrance into the US market in 2007. Tesco has less than 1% local market share in California, Nevada and Arizona. It seems to us that unless your grocery brand or offer provides something materially different then you should not try and compete with such long-established brands.”
Dennis’s views, however, were not shared by all City watchers. Barclays Capital analyst James Anstead agreed that the exit from Japan demonstrated that Tesco was willing to give under-performing operations the chop. “Clearly,” Anstead wrote in a note to clients this week, “the other market that stands out as a problem is in the US.”
Nevertheless, Anstead claimed the situation in the US was “very different” both in terms of Tesco’s operations across the Atlantic and the impact that an exit from the country could have on the retailer’s balance sheet.
“While both are mature markets, in the US, Tesco has entered with a radical new format, whereas the Japanese business was a more conventional supermarket format. We believe therefore that the growth potential in Japan was always more limited,” Anstead said. “Also, although broadly similar in terms of sales, the US division’s EBIT losses are around ten times the size of Japan’s and hence an exit of the US would be a much bigger swing factor for the group. Whilst we still think the jury is out on the future of the US division, all recent commentary from management does seem to suggest that Tesco is happy with the momentum in the business and therefore we do not feel an exit is likely in the short term.”
Anstead acknowledged that Tesco’s decision to quit Japan would mean the retailer’s investors would look at other “loss-making or under-perfoming markets” like the US, plus China and Turkey. However, he added: “We believe Tesco views these countries as much longer-term growth opportunities than Japan was ever likely to be and therefore the decision to exit is significantly harder.”
The exit from Japan has proved Clarke can take tough decisions, which will please Tesco’s shareholders. However, investors will be wise to give Clarke and Tesco more time to work on its operations in China and Turkey, where, Black says, the retailer’s stores are profitable. The Tesco chief has already indicated he is prepared to be patient with Fresh & Easy but its operations in the US would appear the next on the chopping block should its fortunes not improve quickly.