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April 18, 2011

Best bits: Tesco’s Clarke prepares for scrutiny

Tomorrow (19 April), Tesco chief executive Philip Clarke will sit down with analysts and - later - the media to discuss the retailer's financial performance over the last 12 months.

By Dean Best

Tomorrow (19 April), Tesco chief executive Philip Clarke will sit down with analysts and – later – the media to discuss the retailer’s financial performance over the last 12 months. 

The presentations will be Clarke’s first in charge of the UK’s largest retailer. But, after spending 13 years on Tesco’s board and eight in charge of the company’s international business, is there likely to be a marked change in tone or direction from the company’s new CEO?

Probably not. As one analyst told just-food in March, when Clarke formally replaced Sir Terry Leahy, Tesco’s new boss would look to “fine-tune” the retailer, rather than “rebuild the engine”. 

After stints running Tesco’s logistics, IT, European and Asian operations, Clarke has been at the centre of much of the recent changes at the retailer. That said, industry watchers will be keen to hear Clarke’s plans for Tesco’s core UK grocery business and how the company – now the world’s third-largest retailer, according to Deloitte – plans to drive further growth overseas.

Christopher Hogbin, an analyst at Sanford Bernstein, says Tesco’s shares have “performed poorly” over the last two years, which, he argues, reflects concern among investors over margin pressure in the UK and whether the retailer can drive long-term returns from its domestic market. 

Those concerns are very real, particularly with commodity costs remaining volatile, consumer confidence weak and the recent high-profile competitive activity with Asda. Over at Arden Partners, analyst Nick Bubb says Tesco’s UK food business is “struggling” and is keen to see whether Clarke will lead attempts to “revive” the business, or whether the new CEO will “defer” to Richard Brasher, the new MD of Tesco UK under the retailer’s revamped management structure.

Of course, with Tesco’s UK retail business set to have accounted for – according to Sanford Bernstein estimates – over 72% of the retailer’s trading profit in the last 12 months, the company’s domestic market is of paramount importance to the business. However, industry watchers – and those interested in investing in Tesco – should not under-estimate the importance and potential of the retailer’s overseas operations.

Sure, Tesco’s international units can be improved – what business can’t? – But the retailer’s earnings are likely (again) to have been driven by its overseas stores last year, with growth likely to have been boosted by its operations in Asia.

Clarke’s first results day will be watched with interest, not least with speculation in recent days that Tesco could take its domestic sale-and-leaseback programme overseas to fund its international expansion. In which markets will the new CEO look to plant Tesco’s flags in the coming year?

One international market that causes furrowed brows among some Tesco investors is the US. Clarke – like Leahy before him – will face questions about when Tesco will break even across the Atlantic (Clarke, for the record, has forecast 2012/13).

Last week, it emerged that one of the largest retailers in the US, Supervalu Inc, is facing challenges of its own after it reported an annual loss of $1.5bn due to impairment charges and costs from store closures. Even after putting those costs to one side, Supervalu’s net earnings fell by almost a quarter in the last 12 months.

Surprisingly on the day Supervalu’s results were announced, the retailer’s shares jumped almost 17%. Supervalu’s fourth-quarter earnings beat analysts’ forecasts, while the market reacted positively to the retailer’s guidance for its current fiscal year.

However, that guidance still estimates that the retailer’s identical-store sales will fall this year and not all of Wall Street was convinced about the outlook for the business.

“Operationally, [the] business remains highly challenged,” Ajay Jain, an analyst at Hapoalim Securities, said. “The latest results at Supervalu are likely to feed into a growing (mis) perception that sector fundamentals are broadly improving. However, we see no basis to increase exposure to Supervalu at this time.”

The US also saw one of last week’s more significant pieces of M&A in the food sector, with bakery group Flowers Foods continuing the consolidation in the sector with the acquisition of the ailing Tasty Baking Co.

Flowers – which told investors last month that it wanted to grow more “aggressively” – struck a deal worth US$165m for Tasty Baking, which warned in January that it might have to be sold as financial pressures hit the business. Tasty Baking will improve Flowers’ geographic reach and help it drive sales of branded products, the buyer told us last week.

Adding Tasty Baking to its business will boost Flowers’ presence in the Mid-Atlantic and, as well as give the company the Tastykake brand, improve the distribution of its Nature’s Own brand in the region.

“One area of investor concern has surrounded the company’s ability to grow geographically, while effectively taking share from entrenched market participants in highly populous new market territories,” BB&T Capital Markets analyst Heather Jones wrote in a note to clients last week.

“[With the Tasty Baking acquisition], Flowers will incorporate an iconic brand with strong marketing relationships in the highly populous mid-Atlantic and Northeast markets, for which we believe it can more effectively enter and distribute its core Nature’s Own product suite.”

The deal should also help Flowers in its aim to grow sales by 5-10% a year over the next five years – and, notably, for double-digit earnings growth over the same period.

With the US bakery sector consolidating, Flowers faces a fight in maintaining market share and growing sales and profits. The acquisition of Tasty Baking, for all its recent troubles, could be a positive move for the company.

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