Tesco Slides as Analysts Say Lower Prices Will Weigh on Margins

Tesco Plc, the U.K.’s largest retailer, fell the most in almost nine months in London trading after the grocer’s two brokerage advisers said a promise of permanently cheaper prices will hurt profitability.

The shares slid as much as 5.3 percent, the most since June 5, as analysts at Deutsche Bank AG said the U.K. profit margin will narrow to 4.6 percent from the 5.2 percent of the past 18 months. Barclays Plc sees a margin of about 4.5 percent.

Tesco said yesterday it will invest 200 million pounds ($334 million) in permanently lower prices as the grocer fights back against discounters Aldi and Lidl. Chief Executive Officer Philip Clarke declined to be drawn on the margin goal, saying only that Tesco is committed to “lower, more stable prices.”

“The turnaround in the U.K. will take longer than originally anticipated and will require more margin investment,” Deutsche Bank analysts said in a note published after Tesco updated investors on its plans for reviving sales.

The shares were down 4.2 percent at 321.2 pence as of 11:25 a.m. in London. Before today, they were little changed in 2014.

The investment in price will be offset by cost savings -– including 75 million pounds from accelerated global purchasing of merchandise -– and through a gradual reduction of less-effective promotions, said Barclays analyst James Anstead.

“Given potential competitor reaction, Tesco rightly refuses to be drawn on where U.K. margins may settle,” he said.

When asked about the profitability goal at a conference with analysts and investors yesterday, Clarke said only: “The margin will be what the margin will be.”

Carrots, Cucumbers

Among permanent price cuts being introduced by Tesco, a 1 kilogram bag of carrots is reduced to 80 pence from 1 pound, while the cost of a cucumber falls to 49 pence from 65 pence.

The grocer’s move comes three months after Wal-Mart Stores Inc.’s Asda chain, which is vying with J Sainsbury Plc for the position of Tesco’s biggest domestic competitor, said it would invest 1.25 billion pounds in price and quality improvements.

Tesco also plans to accelerate a store refit program that it said is already showing positive results. More than a third of the grocer’s stores have been updated and sales, profit and margins in those outlets are ahead of the others, it said. The target is for all locations to be updated by 2017, U.K. chief Chris Bush said at yesterday’s conference.

“What we want is the most compelling offer for customers,” Clarke said. “That’s going to take us some time.”

Tesco said it will add 150 new convenience outlets a year and make its market-leading online grocery business an even greater area of focus. The online unit made trading profit of 127 million pounds last year, the company said.

Capital Spending

The new plans are “not likely to yield a rapid top-line response, hence we forecast short-term profit sacrifice, but it should leave Tesco well-placed medium-term in multi-channel retailing,” Deutsche Bank analysts James Collins and Niamh McSherry said in the note, reiterating their buy recommendation.

Capital spending will be reduced to no more than 2.5 billion pounds a year over the next three years as Tesco continues to scale back investment in store expansion. That compares with a capital outlay of 3 billion pounds in its last financial year and a 2009 peak of 6.6 billion pounds.

The revised capital spending goal is only slightly below consensus estimates of about 2.6 billion pounds, according to Andrew Gwynn, an analyst at Exane BNP Paribas in London.

Tesco plans to add 0.7 million square feet (65,000 square meters) of new space in the 2015 financial year. That’s half of last year’s 1.4 million square feet, itself down 40 percent from the prior year.

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