Tesco to Step Up International, China Expansion as Domestic Share Plateaus

Tesco Plc, the U.K.’s largest retailer, plans to make China a central part of an accelerated international expansion plan to fuel sales growth as its share of the domestic grocery market plateaus.

Tesco will spend 2.5 billion pounds ($3.9 billion) over five years opening Chinese shopping malls and hypermarkets, Finance Director Laurie McIlwee said today. The Cheshunt, England-based retailer will also increase store openings outside of China by 66 percent this year, with the money-losing U.S. Fresh & Easy chain opening one new store a week, he said.

The grocer, whose 30 percent share of the U.K. grocery market has barely changed in the last five years, is seeking to sustain growth by expanding internationally and adding services such as banking. Tesco Bank will begin offering mortgages and fixed-interest savings bonds this year and bank accounts in 2011, McIlwee said after the retailer reported a 9.1 percent increase in annual profit that matched analysts’ estimates.

“A cash generative U.K. is funding the creation of New Tesco, which will be bigger than Old Tesco within five years, and this will lead to an acceleration in group growth,” Philip Dorgan, an analyst at Ambrian Securities, said by e-mail. “Given the growth opportunities, the valuation still looks too low,” he said. Dorgan has a “buy” recommendation.

Tesco fell as much as 2.4 percent in early London trading as some analysts said international earnings missed estimates. The stock later regained most of the drop, and was down 3.95 pence, or 0.9 percent, to 433.5 pence as of 10:45 a.m.

Chinese Malls

Tesco, which gets about a third of revenue outside the U.K., plans to increase the number of ‘Lifespace’ shopping malls in China to nine from three this year. The malls offer multi- storey outlets of Tesco food and non-food stores, along with further levels of cinemas, restaurants and stores.

About half of the funding for the malls will come partly from joint ventures and other “third parties,” who will contribute about 2.5 billion pounds, McIlwee said. The grocer will use funds from the sale and leaseback of some of its U.K. supermarkets, operating cash flow and its “budget” to fund its half of the investment, the executive said.

“You could sell one 50,000 square-foot supermarket in the U.K. and buy something 10 times the size in China,” he said.

In the U.S., where Tesco had 145 Fresh & Easy stores at the end of the financial year, the addition of more new space will lead to sales growth of more than 50 percent this year, the retailer said. Fresh & Easy made a 165 million-pound ($253 million) loss last year, and that won’t be “much lower” this year, Tesco said, adding that losses have probably peaked.

‘Slow and Steady’

McIlwee said he expects the U.K. grocery market to be “slow and steady” this year as inflation increases. Tesco’s share of its domestic industry has been stable at about 30 percent since 2005, according to Kantar Worldpanel data, having increased from about 17 percent in the preceding four years.

Tesco Bank, which increased profit 13 percent to 250 million pounds last year, has “plenty of scope for growth” as it taps the supermarket chain’s 42 million Clubcard members to sell mortgages and current accounts, McIlwee said.

Tesco reduced net debt to 7.9 billion pounds in the year from 9.6 billion pounds a year earlier after selling property assets and reducing inventory by stocking less food in its backroom storage. The retailer said it expects to cut borrowings to 7.5 billion pounds by the end of the new financial year.

The grocer will pay a final dividend of 9.16 pence a share, increasing the total for the year by 9.1 percent to 13.05 pence.

To contact the reporter on this story: Sarah Shannon in London at sshannon4@bloomberg.net.

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