Tesco faces number of crucial tests in 2010(70281)

Tesco to grapple with plan to expand

From: The Financial Times

When Tesco updates the market next week on its Christmas trading, analysts will be looking for signs that a big promotional push in its home market is paying off.

But the ferociously competitive UK grocery market is not the only area where Tesco faces a crucial test this year. It is also striving to become "the people's bank", while it must make a success of its foray into the US.

According to Dave McCarthy, analyst at Evolution Securities: "Tesco has a challenging year ahead, probably its most difficult year in more than a decade as it faces a number of issues on a number of fronts."

In November 2007, the group invaded the US grocery market - a venture on which Sir Terry Leahy, chief executive, has staked his reputation. But the Tesco juggernaut has been met with the full force of the global economic downturn, which has hit California, Tesco's launch market, particularly hard.

Tesco has 125 Fresh & Easy stores in southern California, far short of the 500 it had hoped for by February 2010.

Laurie McIlwee, finance director, said recently that there were signs of improvement at Fresh & Easy after the business was relaunched, with sales rising 37.4 per cent in the third quarter, and also stronger like-for-like sales.

Consequently, Tesco ex-pects the business to make a loss over the full year close to its $259m ( 160m) deficit of last year.

According to Michael Dennis, analyst at MF Global, Tesco has invested about $1.4bn in Fresh & Easy. He forecasts that it will have lost about $650m between its launch and February 2010.

Tesco has also put an expansion into northern California on hold but has continued to acquire sites in central to northern California. It is opening four stores in the Fresno area, its most northerly location to date.

Lucy Neville-Rolfe, corporate and legal affairs director at Tesco, says the retailer will move further north when it makes sense to do so.

"We did not expect to have the greatest recession since the 1930s. What we have got to do is do the right thing," she says.

Ms Neville-Rolfe also points out that Tesco, which operates in 14 countries, has international opportunities elsewhere. She is upbeat on Asia, which is coming out of recession more rapidly than other markets.

She points to China, which will be a big focus for Tesco this year, and India. The Indian market largely "missed" the recession, and Tesco will be the supplier to Star Bazaar, the hypermarket chain of Tata Group's retail arm, and also plans to open its own cash and carry store this year.

Markets in eastern Europe are also improving, Ms Neville-Rolfe says, as is Ireland.

Clive Black, analyst at Shore Capital, says economic headwinds are abating, not only in Tesco's home market, but internationally.

"A year ago the economic wheels were falling off Tesco's bus," he says.

"Now those wheels are back on and, if anything, Tesco is a little bit of a leaner, meaner machine, capable of going faster in terms of paying down debt and focusing on the business."

But Tesco's challenges do not end in the US. Another issue facing Tesco is whether it can recapture its poise in the UK grocery market, which accounts for more than two-thirds of its profits and sales.

For much of 2009 it lagged behind its main rivals in terms of UK sales growth based on stores open at least a year.

In a bid to close the gap, it has invested hundreds of millions of pounds in its Clubcard loyalty scheme, offering customers double points and mailing out 67m ($108m) of vouchers in November, which would normally have been sent in February.

In spite of the Clubcard assault, Tesco's UK likefor-like sales in the three months to the end of November rose by 2.8 per cent, less than expectations.

"It strikes us that either the [Clubcard] initiative isn't working or that the underlying business is continuing to underperform," said analysts at Morgan Stanley.

Ms Neville-Rolfe says: "I don't think you should draw that conclusion at all. So far we are pleased."

Mr McIlwee says Tesco's third-quarter sales covered a period when spiralling increases in food prices came to an end.

Rivals' figures still included food price inflation.

Tesco expects the beefed up Clubcard to have a bigger impact on its Christmas trading.

Andrew Kasoulis, analyst at Credit Suisse, is forecasting UK like-for-like sales growth of 3 per cent for the six weeks to January 9, in line with J Sainsbury for the third quarter. But even a strong performance could prove controversial.

Mr McCarthy says: "There are more than 100m of extra Clubcard vouchers in circulation against last year.

"If Tesco counts these as cash sales in its Christmas trading statement and treats them as it did in its third-quarter trading statement, it will artificially inflate reported sales by 1 to 2 per cent."

Tesco has rejected any suggestion of additional Clubcard vouchers artificially inflating sales, and Ms Neville-Rolfe says that if they make an unexpected difference to sales, Tesco will make this clear. She adds that vouchers make no difference to profit.

If this were not enough to contend with, Tesco has embarked on an aggressive assault on banking.

While banks are bloodied by the financial crisis, retailers are largely unscathed. Therefore Tesco has a once-in-a-lifetime opportunity to poach their customers.

But building a bank is expensive and time consuming. Tesco admitted recently that it would not reach its goal of having 30 in-store branches by the end of 2009, as it had hoped.

It has also revealed that it may not begin offering a current account - the main banking relationship - until 2011.

However, it is being slightly more aggressive on the potential timing of mortgages, which it could launch towards the end of 2010.

"I don't think we are slipping," says Ms Neville-Rolfe. "We always said a couple of years. If we were to do mortgages [in 2010], that would be quicker rather than slower."

Tesco faces number of crucial tests in 2010

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