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Tesco Reluctance to Commit to U.S. Dims Investor Outlook

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Tesco Plc Chief Executive Officer Philip Clarke
Philip Clarke, chief executive officer of Tesco Plc. Photographer: Matthew Lloyd/Bloomberg

April 19 (Bloomberg) -- Tesco Plc, investing 1 billion pounds ($1.6 billion) to regain share lost in the U.K. grocery market, disappointed investors by failing to give the same commitment to its U.S. business.

The U.K.’s largest retailer yesterday pushed back its profitability target for the Fresh & Easy chain and scaled back store openings. Chief Executive Officer Philip Clarke told reporters that Tesco won’t set a “timeline” for the business.

“Before too long we’re going to have to get a decision” on the U.S., said Richard Marwood, a senior fund manager at Axa Investment Management in London, which holds Tesco stock. The lack of progress at Fresh & Easy took the shine off the company’s announcement of an investment plan to revive sales in its domestic market, he said.

Tesco conceded that the four-year-old chain in California, Arizona and Nevada is making “slower progress” than planned. Only 30 out of 186 stores are profitable, while 118 are “very close,” Chief Financial Officer Laurie McIlwee said.

“We’ve laid out precisely what we see the measures of success are, and that is more stores getting to shop-floor profitability,” CEO Clarke said at a press conference. “When we get there, we will say some more about it.”

Tesco, based in Cheshunt, England, doesn’t now expect Fresh & Easy to break even until during the financial year ending February 2014. That expectation “is testing investors’ resolve as well as our own, there is no doubt about that,” Clive Black, an analyst at Shore Capital in London, said in a note.

U.S. Losses

The delay to U.S. profitability and slowdown in store openings were the “clouds” in yesterday’s earnings statement, said JP Morgan Cazenove analyst Matthew Truman.

Tesco, which in January cut profit guidance for the first time in two decades, reported a 1.3 percent increase in so-called trading profit to 3.76 billion pounds, matching analysts’ reduced estimates. U.S. losses narrowed to 153 million pounds, which was 27 percent weaker than Truman’s estimate.

Tesco said last year it would need 300 stores in the U.S. to break even, less than the 400 it had originally anticipated. The revised expansion plan means Fresh & Easy will have just 230 stores by February 2013.

According to Axa’s Marwood, Tesco needs to increase its scale in the U.S. to absorb the cost of running its own manufacturing and distribution center in California. Having fewer outlets than planned may make it harder to break even.

Customer Service

“It’s a lot of money spent to date, so I suppose part of the problem is they need to decide are you going to stick with this and really do it, or are you going to pull stumps and not,” he said. “They are still rather between the two.”

Tesco’s Clarke remains adamant he can make the business work, citing economic turmoil on the West Coast for delays to profitability. The retailer entered the U.S. in 2007, a year before the collapse of Lehman Brothers Holdings Inc.

“We entered America at a time when the economy was growing, consumers were confident, everyone in the world had a tailwind that was pushing them along and then bang came the headwinds,” the CEO said.

Since then, Fresh & Easy has focused more on customer service, building in-store bakeries and amending its offer to have more own-brand, freshly prepared ready-meals.

“Because it’s such a unique business, because it’s got such extraordinary capabilities, because the market opportunity is real, I feel we need to persuade our investors we can get there,” Clarke said.

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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