Tesco Swaps Global Aspirations for Giraffe Amid Profit Slide

Under Chief Executive Officer Phil Clarke, Tesco Plc (TSCO) is unraveling a global empire that didn’t quite pan out. Investors need him to fare better with the new one that he’s building at home.

In the past year, the biggest U.K. grocer has bought a chain of kid-friendly restaurants, invested in an artisan bakery, and co-founded the upscale Harris & Hoole coffee-shop chain which will also feature in Tesco stores. The goal: to turn the outlets into a destination for more than just the cheapest baked beans and avoid losing more business to online orders, convenience stores and discounters.

The executive, 53, last year pledged to spend 1 billion pounds ($1.5 billion) and do “three years’ work in one” to turn around the business after cutting profit guidance for the first time in years. By December, he was about three-quarters of the way through revamping 450 U.K. stores and had added more than half the 2,000 new value products.

“With all these new projects there’s obviously a risk that it proves a big distraction for management, when the majority of people probably just want the basics to work,” said Bryan Roberts, an analyst at Kantar Retail in London. “At the same time, this is all long overdue and it helps Tesco retake its place as the pioneer of retailing.”

Photographer: Simon Dawson/Bloomberg

A sign sits above the entrance to a Tesco Plc supermarket in London. Close

A sign sits above the entrance to a Tesco Plc supermarket in London.

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Photographer: Simon Dawson/Bloomberg

A sign sits above the entrance to a Tesco Plc supermarket in London.

Earnings Outlook

Proof of a U.K. turnaround is unlikely to be seen this week. Tesco is set to report its first drop in annual profit in two decades on April 17, according to analysts. Full-year trading profit fell 11 percent to 3.4 billion pounds, according to the average of 11 estimates in a Bloomberg News survey. Tesco declined to comment ahead of the announcement.

Clarke, at the helm for two years, has authorized about 170 pilot projects and trials to allow executives to explore all ideas to stem the Cheshunt, England-based company’s declining domination of Britain’s 163 billion-pound grocery market. He’s also spending $750 million globally to develop its online offering, including expanding digital download service BlinkBox.

“The new offerings have made Tesco more interesting and more relevant again,” said Clive Black, an analyst at Shore Capital in Liverpool. “This should help stabilize its market share and once it has done that, it can start batting forward.”

More Competitive

Almost two decades of aggressive international expansion into central Europe, Asia and the U.S. took the focus off its U.K. shops, leaving them tired and allowing upmarket competitors like J Sainsbury Plc (SBRY) and discounter Aldi alike to snap at its heels. Tesco, which paid 40 million pounds to leave its Japanese joint venture, will also this week update the market on a review of its Fresh & Easy chain in the U.S. Clarke has said Tesco will likely leave the market, a move that some analysts have said will lead to a 1 billion-pound writedown.

Clarke in January reiterated his contention that the new plan will make Tesco more competitive and that full-year trading margins in the U.K. would remain similar to the first half of the year at 5.2 percent. That compares with a 5.8 percent margin the previous year and 6.1 percent in the 2011 financial year.

While Tesco’s shares have gained 30 percent since hitting a 2012 low of 297 pence in May, they are little changed compared with pre-profit warning levels, trailing the 12 percent advance of the U.K. benchmark FTSE 100 Index. (UKX) The stock was down 0.5 percent at 383.3 pence as of 9:07 a.m.

Latest Kantar Worldpanel data published on March 26 shows a second consecutive drop in Tesco’s 12-week market share from a year earlier to 29.4 percent from 30.2 percent. A sales increase of 1.1 percent in the period trailed that of the industry total of 2.5 percent.

’Sales Traction’

For now, “we’ve not yet seen a significant amount of sales traction to the investment Tesco has made,” said Andrew Gwynn, an analyst at Exane who sees a 0.7 percent increase in same- store sales for the coming year versus 2 percent for Sainsbury and “at least double-digit growth for Aldi, so Clarke may have to invest further margin to give some oxygen to sales growth.”

Furthermore, adding to the disappointment in the U.S. and Japan, the home market is teetering on the brink of a triple-dip recession and inflation outstripping wage growth. The U.K. economy “is a bit of an Achilles heel and there could be a question of focusing on this business to the detriment of others in faster-growing markets,” said Paul Mumford, a fund manager and Tesco shareholder who helps manage 850 million pounds in assets for Cavendish Asset Management in London.

Harris & Hoole

Don’t tell that to the fans of the 2.90-pound crusty sourdough bread and 1.80-pound croissants the grocer now sells in the U.K. in addition to the typical Tesco standbys of 70- pence baguettes and squishy, white pan. Its 48.5-million pound acquisition of Giraffe restaurants last month will allow the grocer to sell hot duck stir fry, Mango Mama smoothies and Rekorderlig Swedish Premium cider to young families looking for food that doesn’t come from a deep-fat fryer. Tesco says the upscale offering will give shoppers a reason to stick around.

“There is no reason that supermarkets can’t offer something similar,” to shopping malls where people meet friends and dine out, Kevin Grace, Tesco’s group commercial director, said in a blog post last month. Harris & Hoole coffee shops, Giraffe and Euphorium bakeries will be rolled out in selected stores across the country.

While that may help drive footfall to superstores, Tesco needs to concentrate on getting its basics right, said Richard Marwood, who helps manage 554 billion euros ($727 billion) at Axa Investment Managers in London and holds Tesco stock.

“Having a good food offering is obviously a pre-requisite, but I don’t think people will have much use for the bells and whistles,” Marwood said. “You want to drive to a supermarket, load up the car with food and go. It’s not really a destination and you certainly don’t want to spend all day there.”

To contact the reporter on this story: Gabi Thesing in London at gthesing@bloomberg.net

To contact the editor responsible for this story: Celeste Perri at cperri@bloomberg.net

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