Tesco CEO Philip Clarke has conceded the growth of online grocery retailing in the UK has had a negative impact on the performance of its physical stores.

The UK’s largest retailer booked its second year of declining profits today (14 April), with underlying pre-tax profits down 6.9%. During the 12 months to 22 February, the group’s total sales fell 0.2%, including currency exchange, to GBP70.89bn.

In Tesco’s closely watched domestic business, like-for-like sales fell 1.3%. The company said sales were “held back” by an “increasingly competitive grocery market in the second half”.

Clarke said Tesco’s performance had been hit by the ongoing impact of the “consumer recession” as households continue to seek ways to reduce spending despite signs of wider economic recovery. He also flagged the effect growing online sales have had on the group’s core in-store revenue stream.

“And then there is the impact of the internet effecting bricks and mortar retailing, online retailing is huge in the UK,” he said.

Tesco has taken a number of steps to strengthen its multichannel capabilities. The group is growing its online business, developing its subscription-based delivery model and integrating online, mobile and physical retail methods to create what it calls a “seamless” customer experience. It is also investing in its store portfolio, with a drive to turn its big-box outlets into “destination” stores.

However, Clarke admitted efforts to turn around declining like-for-like trends will take “some time” to bear fruit. “It’s going to take some time. We are not opening a lot of new space these days and you can see these long run impacts of this tightening recession. And the growth of online. Online retailing growing for everybody in the UK.”

Tesco reported an 11% rise in online sales during fiscal 2013/14.

While online sales are growing – and Tesco has insisted its online business is profit-making – there is some concern online returns fail to stand up to in-store profit margins and are therefore likely to have a dilutive impact on earnings.

In addition, Tesco is facing growing competition from the discount sector with the growth of Aldi and Lidl continuing apace in the UK.

“[Tesco] faces significant challenges from a weak consumer climate and intensifying competitive pressures as from the discounters at one end of the market and the likes of Waitrose at the other,” George Scott, an analyst at Conlumino, noted.

Tesco’s response has been two-fold. The group has announced a swathe of price cuts on “basic” items, Clarke said. “In February, March and in April we’ve been reducing prices and customers are responding very favourably. We’ve been reducing the prices of those lines that matter most to customers, the ones that appear on their plate, on their table every day. Volumes are improving, there is more to come of the next few months.”

However, he insisted: “It isn’t just about price, it’s not only about the price you charge for things. It’s about the quality, the range, the service and the overall environment. Which is why we are accelerating our programme to bring a new Tesco to so many neighbourhoods this year. We are going to refresh over six hundred of our stores.”

At the 300 large-format stores Tesco refreshed over the past year, the group reported sales growth of 3-5%. However, as Bernstein analyst Bruno Monteyne stressed, that implies a 5% drop in sales at its non-refreshed stores.

In a note to investors, Monteyne expressed concerns Tesco’s grocery performance is showing accelerating signs of weakness. While Tesco has highlighted non-food issues played a part in the weak 2013/14 performance, Monteyne suggested that could now have extended to grocery. 

“Since the year end, non-food has begun to outperform food, with food growth turning markedly negative,” he observed. “Tesco is clearly continuing to stick to – and accelerate – its [UK] plan… However there is no data that supports that the strategy is beginning to work; UK trading margin in H2 (4.9%) was below H1 (5.2%), even before the recent price investment; and like-for-likes are declining, with like for likes of -3% in Q4 below the -1.5% in Q3.”