Tesco Failing to Reverse 22% Decline Promises More Fresh

A year since succeeding Terry Leahy as chief executive officer of Tesco Plc, (TSCO) Philip Clarke has few reasons to celebrate.

Clarke’s anniversary this week coincided with the U.K. retailer’s dominant share of the 151 billion-pound ($241 billion) grocery market slumping to a seven-year low as competitors win business with a focus on quality and innovation. Some shoppers are heading upscale to such premium chains as Waitrose Ltd., while others are seeking savings at discounters such as Aldi and Lidl, according to a report from London-based researcher Kantar Worldpanel.

To revive sales growth that’s slowed to almost half that of Britain’s food-retailing industry, Clarke is promising to go beyond Tesco’s failed discounting strategy. Instead, the mega chain will offer more fresh-food and product choices. Still, profitability in the U.K. may never regain its 2009 peak, according to Jan Meijer, an analyst at ING Groep NV.

“They clearly became too price focused and that’s not a differentiator in the supermarkets anymore,” Natalie Berg, an analyst at Planet Retail in London said, given J Sainsbury Plc’s Price Match, an everyday low price guarantee by Wal-Mart Stores Inc.’s Asda and William Morrison Supermarket Plc’s Price Crunch.

Tesco shares have dropped 22 percent since Clarke took over on March 2, 2011, rattling shareholders accustomed to an annualized 12.7 percent total return per year under Leahy, who spent 14 years building the Cheshunt, England-based company into Britain’s biggest retailer. Tesco’s share of grocery spending fell to 29.7 percent in the 12 weeks ended Feb. 19, from 30.3 percent in the same period a year earlier, Kantar said.

Years to Recover

The “Tesco supertanker will likely take some turning,” said John Kershaw, an analyst at Bank of America Merrill Lynch in London. “Investors are right to remain cautious.” Kershaw cut the stock to “underperform” from “neutral” on Feb. 22, one of at least 10 recommendation downgrades since Jan. 12.

“Clarke has a job on his hands now,” said William Hobbs, who helps manage 164.2 billion pounds in assets at Barclays Wealth in London. Hobbs said his fund removed Tesco from its portfolio in January after the grocer posted sales that missed estimates and forecast “minimal” profit growth in 2013.

Food retailers can take years to recover after reducing profit forecasts and often underestimate the amount of work needed to turn around underperforming units, according to Deutsche Bank AG analyst James Collins.

Store Trial

Carrefour SA (CA), Tesco’s largest European competitor, lowered its profit forecast twice in three months last year and in January said profit would be at the lower end of its range as weaker discretionary spending hurt sales. J Sainsbury, (SBRY) the U.K.’s third-largest supermarket company behind Tesco and Asda, has not fully recovered past levels of profitability since reporting a pretax loss in 2005.

Clarke, 51, started working for Tesco as a stock boy at 14 and became CEO after overseeing international expansion. The retailer gets about a third of revenue from countries other than the U.K. such as South Korea, Poland and the U.S.

“It’s range, quality and service where we feel we can be much stronger” in Britain, Clarke told investors in January, adding that employees will be given additional training in areas such as customer service and fresh food.

Tesco has made changes at a medium-sized “Metro” store on Tooley Street near London Bridge, including a green-uniformed “Fruit and Veg” team that checks for damaged produce every 30 minutes. Signs identify the store’s fishmonger by name and the wine section is decked out with burgundy-and-wood trimmings.

Organic Garlic

The outlet has a self-serve salad bar, in-house bakery with hot croissants and a Krispy Kreme donut concession. There are also color-coded signs for each category, wider aisles, brighter lighting and cleaner floors than neighboring Tesco stores.

Fresh items under a “Tesco Organic” banner include a black garlic bulb for 1.40 pounds, while a plastic-wrapped ham roll in the “Fresh Today” section costs 1.60 pounds. Five aisles are dedicated to produce in closed-door refrigerators, such as chicken breast and chilled prepared meals.

Gail Nield, a 52-year-old office administrator who works locally to the Tooley Street outlet, said she now regularly buys ready-meals and takeaway lunches there. Most Tesco stores offer a “fairly dismal environment” and need updating, she said.

A Tesco spokesman declined to comment on the Tooley Street store, saying that trials have focused on putting more staff into areas such as fresh foods.

Reduced Estimates

Tesco’s U.K. trading margin, at 6.1 percent of sales in the year ended February 2011, may fall to 5.3 percent in fiscal 2012 and take many years to return to 6 percent, according to Black. ING’s Jan Meijer said the margin, or operating profit excluding some items as a percentage of sales, “will be lower forever” and cut his estimate for the year through 2013 to 5.4 percent.

In the last four weeks, estimates for Tesco’s earnings before interest, tax, depreciation and amortization in fiscal 2012 have fallen by 20.2 million pounds, according to data compiled by Bloomberg. For the following two years, they’ve been cut by 49.3 million pounds and 51 million pounds, respectively, the data shows. The grocer reports annual results on April 18.

Analysts haven’t written off Clarke’s chances of turning the domestic business around. About 31 percent have a “buy” recommendation on Tesco, compared with 20 percent for Sainsbury and 7.5 percent for Carrefour.

“We think that Tesco is fixable,” said Philip Dorgan, an analyst at Panmure Gordon in London with a “buy” rating on the stock. “It won’t be a rapid turnaround, but it can be done.”

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

To contact the editor responsible for this story: Sara Marley at smarley1@bloomberg.net

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