Tuesday, September 30, 2008

News & Analysis: Tesco Reports Half-Year Financials; Reports Loss For Fresh & Easy USA and Sales Per Square Foot Averages

United Kingdom-based Tesco PLC, which owns and operates Fresh & Easy Neighborhood Market USA, reported today its interim (half-year) net income rose 11% to 1.04 billion pounds ($1.9 million) in the six months ended August 23, from 936 million pounds a year earlier.

The gain was the smallest for Tesco since 2001. However it out-performed the estimates of most financial analysts who follow the global retailer. Citibank, which we quoted here yesterday, pegged the 11% number ahead of today's reporting. Tesco PLC stock added 4.8% in trading today on the London Stock Exchange on its report of the 11% gain in half-year net income.

Sales excluding value-added tax increased 13 percent to 25.6 billion pounds, Tesco said. However, non-food same-store sales growth in the U.K., Tesco's number one trading region, slowed to 4 percent from 8 percent in the second half of last year.

You can view Tesco PLC's complete half-year financial report here.

Fresh & Easy Neighborhood Market USA

Tesco reported sales and profit/loss numbers for its small-format Fresh & Easy Neighborhood Market combination grocery and fresh foods retailing chain today for the first time since launching the venture in the Western U.S. states of California, Nevada and Arizona.

Tesco reported sales of 76 million pounds ($150 million) for Fresh & Easy, which currently operates 90 stores in the Western U.S.

Tesco reported a loss for Fresh & Easy of 60 million pounds ($118 million), based on a 9 month trading period. The first Fresh & Easy store opened in late October, 2007 in Hemet, California. Therefore, using November 1, 2007 as a fair start date, Fresh & Easy stores have been trading for an actual 11 months total. Tesco however used a 9 month period based on its half-year fiscal analysis.

Here's how Tesco reported Fresh & Easy's sales and income loss in the report today:

"A segmental report on the United States is included in International for the first time with these results. US sales and initial trading losses were previously reported within the UK segment. Fresh & Easy had no stores trading during the first half of last year so comparatives are available only in respect of start-up losses in 2007/8. US sales were £76m in the first half and trading losses were £60m, (last year trading losses were £17m). These planned losses reflect the fact that the US business – which has been trading for nine months – has been built with the necessary infrastructure in place from the beginning to support hundreds of stores. At this stage, it is therefore operating with high overhead and other costs in relation to the scale of the business, whilst also trading from immature stores."

Andrew Higginson, Tesco PLC's chief financial officer, said today in a statement he expects Fresh & Easy Neighborhood Market USA to break even by the next fiscal year.

Tesco also released some additional sales data today for Fresh & Easy.

Tesco said the average Fresh & Easy store is trading at $11 per square foot per week. According to the Food Marketing Institute (FMI) , the major U.S. food and grocery retailing trade association, U.S. supermarket industry average sales per square foot are $11.27 (2007 figure).

Tesco also said its best performing Fresh & Easy stores are trading at more than $25 per square foot per week. However, there's no mention if "best performing stores" means 2 stores, 5 stores, 10 or 25 "best stores." Therefore it's not a very meaningful number in terms of comparing it to the $11 per square foot sales average. Obviously it can't be more than a handful of stores. If so, the $11 average number would therefore be higher.

Additionally, Tesco said Fresh & Easy stores that have opened since spring, 2008 "also appear" to be performing above the average, at $13 per square foot per week.

Fresh & Easy Buzz has previously reported, based on information from sources, that a few of the Fresh & Easy Stores, such as the Manhattan Beach, California unit which opened on July 2 and a couple others opened after that this summer, are averaging about 200,000 in weekly sales. However, that's far from the $25 per square foot per store sales Tesco reported "some" of its best stores are doing. Perhaps we've missed those stores?

However, the $13 per square foot per store number fits with those handful of stores, like Manhattan Beach, our sources tell us are doing in the $200,000 per week average range. However, our information is that those stores are units opened this summer after July rather than in the spring as Tesco reports. Perhaps we've missed a couple of those stores as well?

Mike Dennis, an analyst at the Piper Jaffray-UK investment firm who follows Tesco PLC and has been closely following Fresh & Easy since Tesco set up shop in Southern California about three year's ago, said about the reported $118 million loss for Fresh & Easy Neighborhood Market: "The interesting point on US losses was the $118 million loss could be $25m start-up and $93m trading losses which if right would imply negative margins of 62% obviously due to discounting and lack of op leverage on high depot fixed costs." By depot he is referring to the 800,000-plus square foot Fresh & Easy distribution center in Riverside County, (Southern) California.

"I assume to get to $200m FY (fiscal year) loss (breaking even by the fiscal year as Tesco CFO Andrew Higginson suggest will occur) they (Tesco) will need to do a sale and leaseback on (the) Riverside (County) depot," Dennis added.

Tesco analyst Dennis also says the idea the $11 sales per square foot per store Tesco reported for Fresh & Easy "is good is laughable" because rather than benchmark the sales strictly based on supermarket (like Vons and Albertsons, two chains in Southern California) format average sales per square foot ($11.27 according to FMI), it should be measured closer to convenience store (because the Fresh & Easy stores are a hybrid grocery and convenience-oriented format) sales per square foot, which are higher than supermarket averages.

Fresh & Easy Buzz's most recent sales per square foot estimate for Tesco's Fresh & Easy Neighborhood Market essentially matches the $11 per square foot per store number reported today by Tesco PLC.

Our most current average per store sales estimate range for Fresh & Easy is 125,000 -to- 150,000, with our average per store sales estimate single figure at $130,000

Fresh & Easy stores range in size from 10,000 -to- 13,500 square feet. If you pick the mid-range square footage number between that store average range and multiple it by $11 (sales) per square foot, you will see we are right in the ballgame with our numbers. For example, using 11,500 square feet as the mid-range, and $11 sales per square foot, the total is $126,500 in average weekly sales. Our estimate is $130,000, within a range of $125,000 -to- $150,000.

Not only is Fresh & Easy Buzz the only publication (that we can find) that's gone out on the limb to offer such an estimate in recent times, we're obviously pleased with its accuracy.

In fact, you can read this piece from yesterday, "Tesco PLC to Report Interim Financials Tomorrow; Including Guidance on Fresh & Easy Neighborhood Market USA,," in which we published our sales estimates. We also published our estimates in this September 26 piece, "Tesco PLC, Fresh & Easy and the Numbers Game; Will Tesco Release Hard Numbers For Fresh & Easy Next Week? If So, Will They Be Meaningful?." We've published the estimates in a number of other stories prior to September 26 as well.

Tesco's original average per store weekly sales target for its Fresh & Easy stores for this point in time was about $200,000, rather than the current numbers.

While current average sales are a considerable shortfall from that target, they are much better that what the stores were averaging in the first quarter of this year. At that time our estimate was sales of about $70,000 -to- $100,000. At current averages of say between $120,000 to- $130,000 it's a considerable improvement.

However, it's our analysis a significant portion of that sales lift has come from Tesco Fresh & Easy's aggressive use of its deep discount $5-off coupons, which can be redeemed for full face value by shoppers on purchases of $20 or more in the stores. That deep discount amounts to a whopping 25%-off on a $20 grocery purchase.

These coupons are mass-mailed to residences and handled out in the stores in multiples to customers. They also are used frequently by shoppers. Tesco has been using them since the stores first opened last year.

It's our analysis the aggressive use of the deep-discount coupons has provided an "artificial" sales lift to the Fresh & Easy numbers, well beyond the type of lift average supermarket chains get from coupon use and redemption.

We aren't going to quantify the percentage of the sales lift attributable to the aggressive use of the deep discount coupons since we don't have sufficient information at present to do so in our estimation.

However, the coupon use is significant -- and it's our analysis if the 25% deep discount value coupons were either reduced by say 50% (which would still be a deep discount compared to what competitors offer) or eliminated completely (very few U.S. retailers use such coupons on any regular basis, let alone for nearly a year like Fresh & Easy has been doing) there would be a significant shortfall in the grocery chain's current $11 per store per square foot average sales number.

But in the longer view, Tesco's Fresh & Easy certainly is doing far better than many other analysts have suggested. Since our most recent sales estimates are in line with today's reported numbers for Fresh & Easy, we've been far less likely to sound the third alarm bell -- maybe 1.5 at this point in time -- like a number of other analysts have been continually doing.

However, that doesn't mean it's our analysis Fresh & Easy is on solid footing. Far from it. For example, we disagree with Tesco's chief financial officer that the company will likely break even in the next fiscal year. Maybe. But we doubt it.

We disagree for a number of reasons, but chiefly because starting next year Tesco will enter the Northern California market, opening a distribution center and the first of what so far are about 45 -to- 50 stores, some confirmed by the retailer and others we've identified in our reporting. (This doesn't include the Bakersfield and Fresno region stores set to begin opening next year in the Central Valley.)

Northern California is a very different market in many qualitative ways than Southern California, Southern Nevada and the Phoenix, Arizona Metropolitan region, where the current Fresh & Easy stores are operating.

In our analysis, Tesco will find itself burning up far more investment money (on a per-capita basis at retail) in entering and operating in the Northern California market (San Francisco Bay Area and Sacramento/Vacaville Metropolitan region) than it has so far in its retail operations and marketing/merchandising (we aren't talking about start-up costs for distribution, ect.) in its current three market regions.

We will save our extensive analysis of the reasons why this will likely be the case for another time -- and for another piece devoted exclusively to that topic.

For now, suffice to say the competition for Fresh & Easy will be stronger and more varied in Northern California, the consumer base is qualitatively different, and the external issues are much more difficult for a retailer to deal with than is the case in Southern California, Nevada and Arizona.

As a result, we doubt Tesco will see break even as soon as the fiscal year.

On the other hand, we suggest those who continue to count Tesco out with Fresh & Easy do so at their own peril, so to speak.

If Tesco's Fresh & Easy can execute its operations better, improve its merchandising and marketing significantly, and stop having such high employee turnover in key areas like corporate merchandising and buying (along with doing a few other things differently and better), there are a number of current trends in Western U.S. food and grocery retailing (and externally) that suggest a smart, savvy, well positioned small-format grocery chain could do extremely well.

For Tesco's Fresh & Easy, time -- and those improvements and changes -- will tell.


Anonymous said...

Excellent analysis of what is a complex scenario. I for one wonder how the credit crunch affects the ongoing planning for Fresh and Easy. In UK, Tesco have taken on the threat from Aldi, Lidl and Wall-Mart (ASDA) by slashing prices and introducing new cut-price ranges.

One interesting fact about Tesco and Wall-Mart is that wherever in the world (outside USA) Tesco and Wall-Mart have gone head to Tesco has come out on top.

Philip said...

Your analysis of Fresh & Easy over several months has rested on the assumption that your claim that Tesco had a hard target of weekly sales of $200,000 per store for Fresh & Easy is unimpeachable. Your constant repetition of this in the face of Tesco's claim that sales at a much lower level are ahead of target, amounts to an assertion that management is lying. What is your source for the $200,000 figure, and why are you so confident in it? I have been following Tesco probably since many years before an American would even have heard of it, and they have never announced such a target for any of their UK or international chains in my recollection.

Fresh & Easy Buzz said...


Thanks for being a regular reader of Fresh & Easy Buzz despite your view our analysis stinks.

Thanks also for your comment.

The $200-k average weekly sales target was stated by Tesco well before the stores opened in Fall 2007.

It's a number UK stock analysts have used in conversations with Tesco's CFO as well.

If you read our pieces and analysis closer, you will find most of the time we also stress it's just a "sales target," and that such targets are just that -- goals.

We've never made a big deal out of it per se. But it is a target -- therefore it's fair to benchmark sales against it.

Additionally, we have never used the term "hard target." You manufactured that to try to make your argument stronger.

If you can find one story in Fresh & Easy Buzz in which we used "hard target" please publish the link here. We then will say we used it and made a mistake in saying we never have.

Further, our analysis rests on numerous pilars. To say it rests entirely on the mention of the $200-k target is once again a fiction on your part.

For example, the primary pilar of our analysis is sales per square foot. As we mentioned in this piece, that has imporoved greatly for Fresh & Easy. Using the supermarket standard ($11.27), F&E's is 27-cents below the industry average, based on what Tesco has reported.

Tesco also reported some of its stores are doing $25 per square foot. That's a great number. But it also means that if more than one or two Fresh & Easy stores are doing that number, then a number of them are doing well below $11 per square foot. That's merely a math fact -- not an analysis.

Using a hybrid supermarket and c-store standard, it's more than that below.

We also offer a fair analysis and opinion that Fresh & Easy's sales are somewhat inflated by the aggressive use of the $5-off on $20 purchases.

The fact Fresh & Easy is using such a deep discount coupon (25% off) confirms that. If they didn't need the sales encouragement why would they use such a deep discount coupon as an everyday practice?

There is not one other grocery chain in the U.S. currently using coupons of that value on a regular basis. Fresh & Easy has distributed the coupons ubiquitously and in multiples for nearly a year now.

If you really follow Tesco closely, you will know that in the UK the retailer only periodically uses such coupons or vouchers. And when it does they are of about a 50% less value than the F&E $5-off on $20 or more purchases.

A smart analyst should ask why Fresh & Easy is distributing these deep discount coupons as a matter of regular practice. Why do you suppose they are doing so, rather than say doing a drop once every 3 or 4 months, for example? It's simple: to create sales on a regular basis.

Lastly, you say you have been following Tesco for more years than "an American would ever have heard of it." Who told you the writers of Fresh & Easy Buzz are Americans? Assumptions can be dangerous.

Also, who told you one or more of the writers of Fresh & Easy Buzz isn't in his or her 60's or 70's and first heard of Tesco when they were 18 years' old. Don't know your age. But if you are under those age ranges then would suppose you are incorrect.

The point is, assumptions and straw men do not an argument make.

We welcome an argument here though from you about Fresh & Easy Neighborhood Market's current sales, loss, and future potential, along with any other real insight you can provide since you've been following Tesco far longer than an American would even have heard of it.

Thanks again for being a regular reader.

PS: We clicked on your Blogger link so we could view your Blog. However, it says essentially it is a private Blog with restricted access. That's the first we heard of that. How can one view it?

Anonymous said...

I shop at a Las Vegas Fresh & Easy about once a week. Spend small amount of $25-$50 there since we also shop at other supermarkets. Each time I am in the store they give me at least 2 of those $5 coupons, sometimes 3. Have a dozen or so at home. Been this way since the store first opened. Not complaining. Nice savings. But having worked in food retail in the past for many years and also know it isn't sustainable.

Philip said...

I never claimed that you had used the term "hard target". If I had been making such a claim, I would have put the term in inverted commas. Your comments on the number suggest to me that it is an aspirational target, and not the number which would have been used to calculate Fresh & Easy's first year budget. If that is the case, you are making too much of the fact that actual sales are at a lower level. It seems to me that you just don't know whether Fresh & Easy is meeting Tesco's internal expectations, which is what I would expect to be the position.

You commit the sin you accuse me of by saying that I have claimed that your analysis rests "entirely" on that number, when anyone who reads my post can see that I did not do so. I don't think your analysis "stinks", but I find your denial that you make a big deal of the 200,000 number incredible, and suggest that you re-read your own posts.

You seem to imply that I am determined to see Fresh & Easy as a success regardless of the facts, but that is not the case. I think that opening in the U.S. was a huge risk, and if it fails, the sooner Tesco accepts that failure and pulls out the better. India and China are the key growth markets for Tesco in my opinion.

My point about your nationality was merely speculative - what careful reader doesn't want to know the background and motives of a writer - and it was rude to lecture me in response. I don't have a blog, I expect I was forced to sign up for an account by Blogger to gain access at some point in the distant past, but I don't remember anything about that. You however are writing a voluminous blog. If you are going to get upset when people speculate about where you are coming from, and care enough about where a casual comment poster is coming from to go looking for evidence in his non-existent blog, perhaps you should disclose your background(s).

Fresh & Easy Buzz said...

Philip, we aren't in the least bit upset about your comment. As we said in our comment at right, we welcome your comments -- and we even thanked you for contributing.

Regarding "hard target," it is what you said in the very first sentence of your comment reproduced below:

"Your analysis of Fresh & Easy over several months has rested on the assumption that your claim that Tesco had a hard target of weekly sales of $200,000 per store for Fresh & Easy is unimpeachable."

If it wasn't in your text we never would have brought it up.

You seem to have a lot of anger over this issue for some reason.

But as we said, we appreciate your contribution.

If we had an agenda, why would we publish your comments since they are moderated?

Again, please read our various pieces about the sales vs $200-k target. In more than one of them we even state it's merely a target, that targets are just that -- goals, ect.

Targets are important in that they are based on minimizing loss -- sales to target -- not in terms of something that if it isn't hit means failure for a retailer.

We personally think it's way to early to even discuss failure regarding Tesco's Fresh & Easy, which you bring up in your comment. But we have no problem with you doing so.

Regarding Tesco's success or failure, throughout our coverage we frequently say the jury remains out on that. We also say those who rule out Tesco's success do so at their own peril. We say that because Tesco is a top notch retailer. (Of course if we choose we have the right to say we think it will fail...but that's not our analysis or opinion -- the jury is still out on succes or failure.)

They question regarding your Blogger Blog is an honest one.

Whenever we get comments that have a Blogger Blog link like yours has (which is often), we click on it so that we can read that person's Blog to learn about what they are writing about -- be it marketing, politics or kittens. We did that on yours and it came up as saying essentially mo profiler exists and no way to access the Blog. Since we've never experienced that before, we asked you about it -- and how to read it.

We have no interest in who you are. Just asking how to access the Blog since it says what it says here:


Apparently based on your explanation there isn't a Blog there. That's fine.

Again, we appreciate your comments.