Why is Tesco still faltering despite turnaround plan?
Joshua Raymond, chief market strategist at City Index Group who specialises in European equities and Forex, spoke to ShelfLife about the reasons why Tesco can't seem to pull itself out of a slump despite implementing major changes over the past year and the reason the retailer is keeping schtum on its figures for the Irish arm of the business
13 December 2013
Tesco has just posted a subdued set of results with UK like-for-like sales (excluding VAT and fuel) dropping 1.5% in Q3 (13 weeks to the end of November 2013). What do you predict will the company have to do in the next quarter in order to claw back some of these losses?
The Christmas period is now perhaps one of the most significant periods in Tesco’s history. Tesco is going into the all important trading season on the back of yet more sales declines, falling market share and weak confidence amongst its shareholders. The turnaround plan is faltering and to make matters worse, its competitors such as Sainsbury’s and Asda are not seeing a similar trend. One of the ways to attract lost footfall to its stores is by cutting sales prices. Let’s not forget, cutting prices is one of the quickest ways to highlight points of difference to prospective and lost customers whilst at the same time, Tesco could see additional benefits of cross selling increased footfall to non-food items over the Christmas period. Yet CEO Philip Clarke has already indicated that Tesco will not get dragged into a price war and so this appears unlikely at this stage.
If Tesco is to amplify profit margins, then it’s got to be about clever marketing and cost efficiency. Operating margins fell to 5.2% from 6% over a year ago. Declining margins can only be countered by a boost in sales and this is where Tesco is currently faltering. It needs to boost margins and boost sales, together. A big weighting on the sales declines was a weak performance at its UK grocery market. Here is where Tesco must focus during the next quarter.
Tesco is 20 months into a turnaround plan for its main UK business that has seen over £1 billion invested in store revamps, staff, new products and pricing initiatives. Do you believe that the company needs more time for these changes to take effect or has the company not done enough to overhaul the business?
I think Clarke absolutely needs more time but that time is fast running out. In my opinion he has three more quarters to deliver real traction in the turnaround plan or shareholders will be calling for him to go. In three quarters’ time he will at the head of the UK’s largest retailer at a time when it should have benefitted not only from the Christmas trading period but also solid quarters of expected strong UK growth. And what’s more, there is a major sporting occasion next summer, the World Cup in Brazil, which should also be seen as an opportunity to maximise retail sales, particularly if we have a good summer of weather. At a time when its cheaper rivals such as Aldi, and its more mainstream rivals such as Sainsbury’s and Asda are performing extremely well, the window of opportunity to fix the retailer from within is narrowing.
Tesco chief executive Philip Clarke has said that continuing pressures on UK household finances have made the grocery market more challenging for everyone since the summer. Do you believe this is the only reason for the group’s poor performance?
I agree this is certainly a factor and one can quickly look to the success of cheaper rivals in grabbing market share as an indicator of this. Yet to relate Tesco’s troubles solely to household finances is myopic. Look at Sainsbury’s. Why has it not seen similar struggles? Tesco has struggled to find a balance between the right marketing mix, price, messaging and in-store customer experience. The recession has made customers much more savvy and digitally intelligent. Tesco has to evolve the way it markets its prices and offering. We have not seen it do this yet.
Tesco’s third quarter sales in Ireland fell by 8%, and the discounters Aldi and Lidl are now the multiple’s main competitors. What should the company do to combat the rise of the discounters and to create a point of difference?
The rise of discounters Aldi and Lidl echo one key theme; its customers have become much more price savvy and cost efficient. In that sense, either Tesco needs to find an innovative way to connect with its lost market share and increase footfall through clever marketing, which will take time, or cut prices. I believe the company needs to cut prices in the short term to allow the company breathing space to correctly the longer term problems it faces surrounding in-store experience and digital marketing. Tesco has put a lot of eggs in their launch of Price Promise, but this will only work when they make significant price discounts that stand out and surprise.
While exact figures are not released for the Irish side of the business, what would you estimate is the turnover and profitability of its Irish business as a percentage of Tesco’s overall business? Why do you believe the company will not release these figures?
First and foremost, shareholders have every right to ask for information about performance and so Tesco cannot hide its numbers here. Nevertheless, considering how steeply sales declines deteriorated, it’s easy to see why it has not made the numbers there wholly transparent. Sales in the Republic of Ireland declined by 8.1% in the third quarter, which marked an acceleration from a decline of 4.4% in the previous quarter. Indeed, Ireland was the worst performing region for Tesco in its third quarter.
The group is also facing challenging conditions in its international markets, with underlying sales sharply lower in Thailand and South Korea. What can the company do to improve its fortunes in these markets?
This was mostly driven by exceptional factors, some of which is out of Tesco’s control. In Korea, opening hour restrictions capped its ability to maximise sales whilst in Thailand, the comparatives to the same period a year ago always meant its performance this year would be challenging.
Analysts’ average forecast for group trading profit in 2013-14 is £3.39 billion, down from the £3.45 billion made in 2012-13. Would you agree?
The problem Tesco faces is the volatility of its earnings. I am inclined to agree at this point with the £3.4bn mark but do so with the caveat that this could change quickly depending on the Christmas trading period.
For more insights, visit Joshua Raymond’s page here: (www.cityindex.co.uk/market-analysis/analysts/joshua-raymond/ )