An upturn in sales at Tesco was overshadowed by gloom surrounding the outlook for profits as the retail giant is forced to slash prices amid a fierce supermarket price war.
Tesco shares were the biggest faller in the FTSE 100 on Wednesday after its chief executive, Dave Lewis, warned investors that it faced a “challenging, deflationary and uncertain market”. He said the new management team had stabilised the business and they were no longer in “ the crisis we were 16 months ago”. However, he went on to warn that tough market conditions meant Tesco’s profit recovery would not be a “straight line”.
Price cuts have reduced the cost of an average weekly shop in Tesco by over 3% in the last year, Lewis said, but the grocer would have to do more to stay competitive as it battles the fast-growing discounters Aldi and Lidl. “This will be reflected in the pace of improvement in profitability in the current year, particularly in the first half,” he explained.
Tesco eked a pre-tax profit of £162m in the year to 27 February, compared with last year when it crashed to the biggest loss ever recorded on the UK high street, slumping £6.4bn into the red after taking massive writedowns on its property portfolio and stock. The underlying profit figure was in line with analyst expectations of £944m. Four years ago Tesco was making a £4bn annual profit.
Lewis was parachuted in as chief executive following the sacking of Philip Clarke. The business was subsequently engulfed in an accounting scandal after a whistleblower revealed supplier payments were mishandled – a matter that is the subject of an ongoing criminal investigation by the Serious Fraud Office – when Clarke was in charge.
Lewis said the retailer had made “significant progress” on the turnaround plan he set out in October 2014. He has slashed the number of products on Tesco’s shelves by 18% and devoted the freed up space to bestselling lines.
Tesco also reduced the number of multi-buy promotions by a third in the fourth quarter, and clocked up like-for-like sales growth in the UK of 0.9% – its first increase in three years.
“We have regained competitiveness in the UK with significantly better service, a simpler range, record levels of availability and lower and more stable prices,” said Lewis, who has slashed head office costs and deployed thousands more staff on to the shopfloor.
He said sales volumes in its UK supermarkets – the number of items sold rather than their value – had increased for the first time in five years as “more customers are buying more things more often at Tesco”. This was reflected in the recovery in the performance of its sprawling Tesco Extra stores, where like-for-like sales were down just 0.3% compared with a decline of more than 6% when Lewis took over.
The improvement in the retailer’s fortunes means staff will be paid a one-off “turnaround bonus” worth up to 5% of their salary in May. The payout is in shares but staff are able to cash them in immediately if they want.
One of Tesco’s biggest investments to date has been the launch of seven “farm brands”. The new labels, with fictitious names such as Woodside, Willow and Boswell Farms, were created for a new budget range of produce, meat and poultry designed to compete with the discounters. Prior to the launch a basket of 51 comparable products cost £103.11 at Tesco versus £89.06 at a discounter. The new brands mean that the price of the Tesco basket has now come down to £86.34 – a 16% reduction.
Despite criticism of the fictitious farm names, Lewis said the new brands had proved popular, adding that customers “are more savvy about marketing than they are given credit for”. He added: “Do they come from farms? Yes. Can one farm satisfy all the demand from Tesco? No. The product truth is absolutely right.”
Prior to the update, analysts had been expecting underlying profits of £1.25bn for the current financial year. But Lewis refused to be pinned down to the forecast, stating he “didn’t want to put the business in a place where it has to run to meet a number”.
Stifel analyst James Collins, who rates Tesco shares a sell, said it was not surprising that Lewis was cautious about its ability to grow profits.
“Management has cautioned that investments in the customer offer will impact the pace of profit improvement this year, particularly in the first half,” he said. “This is no great surprise but should rein in the market’s over-optimism about how quickly trading improvements might translate into meaningful profit improvement.”
