Tesco clearly has a lot on its plate. On the one hand, the UK’s largest retailer is focused on transforming its domestic business through a capital intensive programme of store refurbishments and a potentially margin-dilutive drive online. On the other, the need to reverse overseas volume declines in order to shore-up international margins is pressing. CEO Philip Clarke is attempting to perform a complex balancing act. Katy Askew reports.
Unveiling its third-quarter sales figures today (4 December), Tesco revealed it has come under sustained sales pressure with falling like-for-like revenues across the regions in which it operates, both domestically and abroad.
Outside the UK, Tesco saw underlying sales drop 4% in Europe while in Asia LFL sales were down 5.1%.
Within Europe, Tesco said its operations had been impacted by weak consumer sentiment and the ongoing effects of the financial crisis. In Ireland, the slowdown was most stark. Tesco booked an 8.1% LFL drop, signalling that the group is likely to have lost further market share to discounters Aldi and Lidl. The group also saw its sales decline accelerate in Hungary and Slovakia.
In Turkey and Poland, Tesco was able to report sequential improvements quarter-on-quarter – but it should be emphasised that these come on the back of soft comparables. In Turkey, sales dropped 3.5% on the year compared to a 10.7% fall in the second quarter. In Poland the sales descent slowed to 0.7% from 4.5% in the previous quarter.
Meanwhile, in Asia negative sequential like-for-like trends continued in Thailand, where Tesco again pointed to difficult macro-economic conditions. Recent sequential improvements in South Korea were reversed, as the company was hit by regulatory restrictions on opening hours. Only in Malaysia did Tesco see a slight improvement in sales trends.
The steep decline in Tesco’s international sales is likely to hit margins. Lower volumes seem set to have a negative impact on profitability because the firm’s high operational gearing – due to the high fixed overheads associated with its extensive store network – mean that Tesco’s profits are sensitive to such swings.
“The constrained sales create a debate about Tesco’s group margin structure in both near and longer term timescales… Will Tesco be subject to negative operational gearing if weak sales persist? Answer: Yes, but so will the whole trade if weak conditions persist,” Shore Capital analyst Clive Black observed.
The marked volume decline in international markets has again raised questions over whether these businesses are driving returns for shareholders.
Speaking earlier today, Tesco CEO Philip Clarke again insisted that, if necessary, he will make “difficult decisions” when it comes to exiting markets where the UK retailer is failing to deliver value.
In 2012, shortly after Clarke took the helm of Tesco, the company started a phased withdrawal from Japan through the formation of a joint venture with local group AEON. Under growing pressure from investors, Tesco announced it would quit the US and abandon its capital intensive bid to expand in the world’s largest grocery market through its Fresh and Easy format earlier this year. More recently, the company said that it will shift its focus in China through the establishment of a joint venture operation with local retailer China Resources Enterprise.
“It is almost a way of half exiting the market or at least keeping the option open to stay in China without having to invest,” AT Kearney analyst Torsten Stocker told just-food.
Ongoing speculation has focused on the possibility that Tesco could be preparing to pull back further still from its international ambitions.
Responding to rumours the next market Tesco might exit is Turkey, Clarke emphasised the company has not yet reached a decision on whether to pull out of any one market. However, he stressed that if a business fails to perform – and Tesco is unable or unwilling to invest in improvements – the retailer would look to cut the dead weight.
“I am clear: my job is to take difficult decisions. I took us out of Japan, I took us out of the US and I have found a different way of operating in China,” Clarke commented in a media call. “I would never say no to anything… we have to be clear that we can deliver long-term value for our investors or we ought not to be there.”
According to Stocker, Tesco’s withdrawal from international markets is the result of the need to invest in its domestic business. “Tesco’s decisions are being informed by the needs of its UK business. When they look at their portfolio of global businesses, they might have said ‘we really need to invest more in the UK, so we can’t invest as much [elsewhere] as we need to to win’.”
Within its UK business, which accounts for the bulk of Tesco’s group sales, the supermarket operator has also witnessed the acceleration of its sales slowdown. UK like-for-like sales fell 1.5% in the third quarter, coming on the back of a 0.4% like-for-like drop in the first half of the year.
With inflation in the UK standing at just under 3%, Clarke confirmed UK volumes were down 3-4%. “The market significantly contracted in our third quarter,” Clarke emphasised. “That is what impacted our volumes.”
Tesco – and with the country’s other “big four” supermarkets – are facing growing competition in the UK from the German discounters Aldi and Lidl at the lower end of the market and the higher-end supermarkets, such as Waitrose. According to Clarke, in order to fend off this competition Tesco needs to differentiate itself.
“The traditional big four retailers are feeling the pressure of the discounters and the niche players at the other end… We will succeed because we will become multichannel,” Clarke suggested.
Tesco has seen strong growth of its online business. However, online profit margins are weak and as Tesco drives sales in this channel ahead of – and arguably at the expense of – its bricks-and-mortar portfolio there is a fear that the shift could have a dilutive impact on margins. Tesco is also making strides to expand in the other area of growth in the UK retail scene – convenience. The company said its Express business continues to be “positive”.
Conlumino analysts were upbeat on Tesco’s drive to expand its multichannel offer. “The push on convenience has seen positive like for likes in express stores, with the product range in each tailored to the needs of its local area. Online continues to go from strength to strength and Tesco is utilising more of its vast portfolio to provide click and collect services,” they wrote in a note to investors.
However, according to Clarke turning around Tesco’s big-box stores represents both the greatest challenge and opportunity for the UK retailer. “Our biggest opportunity is the large stores… these are where the big effort has to go in, the heavy lifting.”
Tesco has embarked on an extensive – and expensive – store refurbishment programme. “We are doing one a week this year, we do feel the need to go faster,” Clarke said.
“For us its about differentiation its about making sure we create post points of difference. A combination of price, quality, range and service delivered in a seamless way in a lovely store and with a multichannel reach.”
This strategy has met mixed reactions. Bernstein Research analysts Bruno Monteyne and Richard Clarke concur with Tesco’s assessment the market share pressure it faces stems from the “continued problem of having an undifferentiated offer”.
However, with accelerating sales declines 18 months into the turnaround plan, the analysts argue that Tesco has failed to find a viable means of improving its positioning in the market. “It is our view that the deterioration is not simply caused by the transformation having a short term drag on sales, but this is symptomatic of the turn-around not working. After 18 months of the plan A not working, we think the management team should consider its alternatives.”
Tesco management would argue that the strategy simply needs more time to start bearing fruit.
It will also need more money, as refurbishing stores and refreshing shelf space is a costly process. At the same time, Tesco is under pressure to deliver value to its shareholders. The group will undoubtedly need to balance these competing needs as it assesses how to build value in its struggling overseas units.