Tuesday, December 2, 2008

Tesco Reports Respectable Q-3 International Sales Growth; Weakest UK Sales in 15 Years; Fresh & Easy USA Not One of the International Bright Spots

Analysis - With a special look at Fresh & Easy USA

United Kingdom-based global retailer Tesco, which owns and operates Fresh & Easy Neighborhood Market in the Western United States, reported its weakest same store quarterly sales growth for the UK, the retailer's top market, in 15 years. UK same store sales, excluding gasoline sales, rose by only 2% for the third quarter, Tesco's worse performance at home in 15 years.

Total UK sales grew by 5.9% in the quarter, with like-for-like (same store) sales up by 3.2%, including petrol. Excluding petrol, like-for-like sales rose by 2.0%. The last number, the 2.0%, is what analysts and investors focus on.

However, Tesco's overall or total global sales were up a respectable 11.7% for the third quarter.
Tesco doesn't break out its quarterly sales reporting by specific international region.

Tesco currently operates 3,956 stores internationally in 14 countries, including its Fresh & Easy Neighborhood Market small-format, convenience-oriented grocery and fresh foods markets in the Western U.S. states of California, Nevada and Arizona. Nearly half of its 3,956 stores are in the United Kingdom.

Overall "International sales were up 28.1% at actual exchange rates and by 14.6% at constant rates. This included a particularly strong performance in Asia, where sales grew by 29.4%, helped by the Homever acquisition and in spite of the depreciation of the Korean Won against Sterling," Tesco said in a statement today.

"We have seen strong growth in all our European markets, although favourable exchange rate movements have contributed significantly to this - and growth at constant rates slowed to 6%. Despite the economic slowdown in some of our markets, our businesses have done well, particularly in food and grocery categories, and we have seen good market share gains." Tesco said about its overall international operations.

Fresh & Easy Neighborhood Market USA isn't one of Tesco's global retailing bright spots however. About Tesco's Fresh & Easy USA, Tesco CEO Leahy said today:

"The U.S. is in recession," he said on the Tesco Web site in a company produced, public relations-style question and answer session on the company’s third quarter interim results. "The Western United States, where we’re opening, is in severe recession at the moment, so it makes sense to maintain our rate of opening rather than the planned acceleration in the rate of opening because you can’t just buck a downtown of that magnitude. [Fresh & Easy] is very popular. It is well received by customers. The U.S. will bounce back, the Western United States will bounce back. We’ll be able to step up our rate of growth when that happens.

"Our prudent decision to maintain, rather than accelerate our current rate of new store expansion in the United States, given the severity of the economic slowdown in some geographic markets there, will mean that we will open 0.5 million (500,000 square feet or about 45-50 Fresh & Easy stores, which average about 10,000 -to- 13,000 square feet each) square feet for Fresh & Easy during the second half. Our early US stores have now moved strongly into like-for-like growth and the performance of Fresh & Easy overall continues to be pleasing."

CEO Leahy is referring to Tesco's decision, which we've reported on, to slow its new store opening pace with Fresh & Easy, including postponing the grocery chain's opening of its first stores in the Northern California market region, where thus far Fresh & Easy Buzz has identified about 46 locations in the San Francisco Bay Area, the Sacramento/Vacaville Metro region, the Northern San Joaquin Valley and the Monterey coast region where Tesco has locked-in leases for its Fresh & Easy markets.

Initially, as we've reported, the Northern California stores were set to begin opening early this year. Tesco then changed that to the end of 2008, then again to early 2009. It is unsure when the first stores in Northern California will start opening now. But based on our sources it's not likely the first Fresh & Easy store in Northern California will open until the middle of 2009, at the earliest.

Further, based on CEO Leahy's quote above, that Tesco will open 0.5 million square feet (or 500,000 total square feet) worth of new stores in the second half, that means opening only 45-50 new Fresh & Easy markets, which average 10,000 -to- 13,000 square feet in size, during this period.

Since we've already identified 46 Fresh & Easy Northern California locations, and since we know additional Fresh & Easy markets are planned to open in Southern California, Nevada and Arizona (the three existing markets) in the second half (plus up to 13 stores in Bakersfield and Fresno), just doing the math suggests that its rather possible Tesco may not open any Fresh & Easy stores at all in Northern California (Bay Area, Sacramento/Vacaville region, Northern San Joaquin Valley) in 2009. And if it does open any Fresh & Easy stores in Northern California, the number of stores opened would be nowhere near even the 46 locations we've already identified, since opening all 46 would take up nearly all of that total 0.5 million of new square footage Sir Terry Leahy says the retailer will open in the U.S. in 2009.

Tesco plans to open five stores in the Bakersfield region in the far-southern Central Valley of California and eight stores in the Fresno Metropolitan region in the mid-Central Valley.

The first two stores in Bakersfield open tomorrow, December 3. They will be the first Fresh & Easy markets to open in California outside of the Southern California region. These regions are in Central rather than Northern California.

We expect the retailer to go forward with opening these stores. Do note though that they take up at least 130,000 of that 500,000 new store square footage. Therefore putting even more doubt in a 2009 Northern California launch.

Tesco currently operates 102 Fresh & Easy markets in Southern California, the Las Vegas, Nevada Metropolitan region and in the Phoenix Metro area in Arizona.

What Sir Terry Leahy didn't mention today in his Q&A (notice his emphasis on external factors only regarding Fresh & Easy -- the recession, ect.) is that Fresh & Easy's problems existed long before the Western U.S. economy turned demonstrably sour. In fact, up until just a month ago Fresh & Easy Neighborhood Market CEO Tim Mason said the chain was doing remarkable. And, ironically, we learned yesterday from the official board that calls recessions in the U.S., that the country is in a recession, and has been since December, 2007. The first batch of Fresh & Easy stores opened in November-December of 2007.

The fact is the format and stores haven't yet caught on in any significant way in either Southern California, Metro Las Vegas, Nevada and in Arizona. They have a niche customer base more similar to what a conventional convenience store chain or a specialty foods format chain would have. That's not what Tesco has planned for Fresh & Easy. The stores are supposed to be neighborhood grocery stores that shoppers use as primary and to a limited degree secondary shopping venues. Fresh & Easy is nowhere close to achieving that objective, neither in sales or in consumer behavior and shopping patterns.

Notice the part of the quote (in italics) above we have in bold from Sir Terry Leahy, where he says: "Our early US stores have now moved strongly into like-for-like growth and the performance of Fresh & Easy overall continues to be pleasing."

That's what's called a nuanced statement. It is true some of the early (opened in late 2007 and early 2008) Fresh & Easy stores are doing well in like-for-like (called same store sales in the U.S.) sales. But it is equally true an equal number of those early stores are doing poorly in like-for-like sales. For example, two months ago we were told by a source in a very good position to know, that the very first Fresh & Easy store opened, which was opened the last week in October, 2007, in Hemet, California, is not yet even averaging $100,000 in weekly sales; averaging instead about $90,000 -to- $100,00o per week at best.

So, even though Tesco is attributing any and all struggles for Fresh & Easy to strictly external variables like the severe economic recession, that's far from true. In fact, since Fresh & Easy is positioned as a no frills, discount grocery and fresh foods market with prices claimed by Tesco to be 15-20% lower everyday than its competition, one has to ask, as we have in previous pieces, why Fresh & Easy Neighborhood Market isn't doing well in a recession based on that model? After all, there is a mass flight by U.S. grocery shoppers to discount supermarkets and other stores like Wal-Mart and the small-format Aldi hard discount markets in the U.S.

The reason is far more internal than it is external -- a failure by Tesco to properly define the Fresh & Easy format, create a strategy to communicate that positioning, and then execute the marketing and merchandising in a comprehensive, clear and quality manner. For example, in the midst of what is a severe economic recession, and even a worse recession in California, Nevada and Arizona, Tesco's Fresh & Easy is promoting the chain and stores more like its an upscale specialty foods format rather than a discount format perfect for today's difficult economic times.

Fresh & Easy Neighborhood Market USA's primary problem isn't external -- the recession -- nor is it a public relations problem, which is an activity the grocery chain spends way to much time on. Rather it is a basic one -- Tesco's Fresh & Easy has yet to become a good merchant, plain and simple.

Tesco's stock shares jumped by 6.6% today following the release of its third quarter sales figures, a sign of confidence in the retailer from investors. However, Tesco's stock value is down about 40% from this time last year, so that confidence has a way to go in terms of gaining back that value.

"We are pleased with our progress (today's third quarter overall sales), but we are also realistic," Tesco CEO Sir Terry Leahy said today in a statement, citing the current economic climate.

In September, Tesco launched its new "Discounter" range of mid-range branded products like pasta and tea bags, for which it had knocked prices lower. That segment now makes up 5.0% of the company's food and drink sales. The retailer is hoping this product range, along with other discounting measures it is taking, will help improve its UK sales, which account for a significant portion of overall sales as Tesco's top trading region.

At home in the UK Tesco is losing business to deep discounters like small-format, no frills grocers Aldi and Lidl. Additionally, Wal-Mart-owned Asda has been engaged in an aggressive discounting program since the first of this year, which has garnered the retailer some new business in the UK at Tesco's expense.

Tesco still has about 31% of the UK food and grocery sales market share however, which is about as much as the country's number two, Asda, and number three, Sainsbury's, have in combined market share percentage. It's estimated that one of every seven pounds spent at retail in the UK is spent at a Tesco-owned store.

Like the U.S., the UK's economy is racked by recession and its own financial and credit crisis. It's important to note that Tesco, especially at home in the UK, is a general merchandise as well as food and grocery retailer. Many of its stores sell everything from clothing and consumer electronics to gifts and household goods, along with food and grocery items. It is these non-essential, durable goods type items that consumers can't afford to purchase in the UK, just as is the case in the U.S. and most other places throughout the world.

Obviously lack of sales across the board in these durable goods categories is an important factor in Tesco having its weakest sales growth (the 2%) in the UK in 15 years. In other words, its important to realize the same store sales aren't based exclusively on sales in the consumables categories, although food and groceries do make up the largest percentage of overall sales for Tesco.

[You can read and view an interview (the company produced public relations-style Q&A) with Tesco CEO Sir Terry Leahy about Tesco's third at www.tesco.com/investorcentre.]

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