Monday, December 26, 2011

Solid Performance Gives Tesco 'Fresh & Easy' Wiggle Room - But CEO Clarke Shouldn't Sleep Soundly Every Night

The Insider - Heard on the Street

United Kingdom-based global retailer Tesco has lost nearly $1 billion since it launched its El Segundo, California-headquartered Fresh & Easy Neighborhood Market grocery chain in November 2007.

That's a whole lot of money to lose on a food retailing venture, even for the world's third-largest retailer. Walmart is the largest by annual revenue. France's Carrefour is number two globally, followed by Tesco.

But despite its big loss with Fresh & Easy from 2008-2011, Tesco has performed superbly over the last four years.

For example, over its fiscal 2008-2011 period Tesco, which holds an about 30% market share in the United Kingdom and has operations in 14 countries, has grown its group revenue by a very healthy 31%.

In contrast, Walmart Stores, Inc. grew its revenue during the same time period by about 11%, which is far from bad for the mega-retailer from Bentonville, Arkansas, considering it has five times' the annual revenue as Tesco does.

Even more impressive, Tesco has grown its profits by 35% over the last four years, despite racking up hundreds of millions of dollars of annual losses from 2008-2011 with Fresh & Easy.

Additionally, despite continuing to have a negative overall profit margin at Fresh & Easy of around -35%, Tesco has averaged a very impressive profit margin of around 4% over the last four years.

That's more than double the profit margin Kroger Co., the leading supermarket chain in the U.S. and the number two retailer of food and groceries in America after Walmart has turned in over the last four years, for example. Kroger's annual revenue, all of which is generated in the U.S., is fairly close to, although less than, Tesco's.

On top of the impressive metrics detailed above, Tesco has averaged a very healthy return on equity of about 15% over the last decade, which has satisfied all but the most aggressive of its major investors.

It's this impressive performance that, in my analysis and opinion, is why Wall Street and The City (the UK's Wall Street) have been so patient with Tesco and its continuing struggles with and substantial financial losses at Fresh & Easy Neighborhood Market.

It's also why these big institutional investors, like Warren Buffett in the U.S. who owns about 4% of Tesco, will make some noise if Tesco doesn't break-even with Fresh & Easy Neighborhood Market by the end of its 2012/13 fiscal year, which begins February 2012 and ends in February 2013, as CEO Philip Clarke has said will happen, but will give the retailer more time to achieve the goal as long as Clarke and company continue to reduce the loss percentage, as was the case in Tesco's 2011/12 fiscal-half year, when it reported a loss of 23% less ($112 million) for Fresh & Easy than it did for the same period the year before.

Tesco reports the financial results for its 2011/12 fiscal year, which ends in February 2012, in April 2012.

If come April 2012 Tesco posts a 2012/13 fiscal-year reduction in losses at Fresh & Easy similar to what it reported in October 2011 for the half-year, it will get near-unanimous praise from the financial community for its efforts, thus giving Clarke plenty of wiggle room over the next year, in my analysis.

Tesco won't break-even with Fresh & Easy by the end of its 2012/2013 fiscal year though, in my analysis and opinion. But I'm not ready to put any specific numbers to my prediction this far out.

By the way, a loss of say $50-$100 million isn't break-even, as it's been publicly defined by CEO Philip Clarke. It's breaking even. Therefore, I do hope the goal posts aren't changed at Tesco, with a spokesperson next year perhaps suggesting something like, "Well, we didn't mean 'literally' breaking even by the end of fiscal 2012/13."

Conversely, if Tesco posts a loss of say $10-$15 million for Fresh & Easy at the end of fiscal 2012/2013, I will consider that break-even. Perhaps the holiday season has me in the giving mood?

The upcoming year, 2012, is a crucial one for Tesco with Fresh & Easy.

California (south, central and north), metro Las Vegas, Nevada and metro Phoenix, Arizona, where Tesco's 184 Fresh & Easy grocery markets are located, are among the most competitive food retailing market regions in the U.S. The competition in all three states will only get more intense in 2012.

For example, Walmart plans to open its first Walmart Neighborhood Market stores in California next year.

Mega-dollar store chain Dollar General will open its first Dollar General Market small-format grocery stores in California, starting in the north, in 2012. Dollar General opened five of the grocery markets in metro Las Vegas this year, with more units planned for the region.

The coming year will also find Boise, Idaho-based discount grocer WinCo Foods opening its first one or two stores in metro Phoenix. Fast-growing WinCo, which operates mega-stores averaging about 90,000 square-feet, is a competitive force wherever it goes. Metro Phoenix will be no exception, in my analysis.

Tesco has said it plans to open about 50 new Fresh & Easy stores in 2012. Nearly all of those stores will be in California, according to Fresh & Easy Buzz's research and reporting.

Tesco's ace in the whole in terms of its stellar performance over the last few years is its mega-market share at home in the UK, where it has over 2,700 stores and generates about 70% of its annual revenue.

Tesco controls about 30% of the UK market, which is nearly as much as its two leading competitors - Walmart-owned Asda and Sainsbury's - combined.

Asda has an about 17% share. Sainsbury's is very close behind with about 16.3%. Morrisons, the fourth-largest food and grocery retailer in the UK, has an about 12.4% market share. These "Big Four" chains, as they're called in the UK, account for nearly 75% of all food and grocery sales in the nation, according to the data from market research firm Kantar.

I don't see Tesco losing much market share at home in the UK over the next couple years despite the heavy competition there from Asda, Sainsbury's and Morrisons, along with Waitrose at the more up-market end and the hard discounters Aldi and Lidl on the other end. Tesco is a mid-range food retailer in the UK, as are Asda and Morrisons.

Therefore, I also expect Tesco to perform at or near the same levels it has over the last four years, despite continuing losses at Fresh & Easy in America.

As long as this is the case, Tesco CEO Philip Clarke will continue to get his wiggle room for Fresh & Easy from investors until early 2013, when the retailer reports its fiscal 2012/13 results, which if Clarke is right will include breaking even with what then will be a five-year-old and some change Fresh & Easy Neighborhood Market chain in America.

What I describe though is only the midfield game for Clarke and Tesco when it comes to Fresh & Easy. In other words, getting to break-even by fiscal 012/13 end and doing so without experiencing the wrath of investors is merely job one.

The bigger picture, which is if Fresh & Easy Neighborhood Market is actually a viable food and grocery retailing model and business for Tesco in the U.S., is what Clarke must also be thinking very seriously about. I don't know about him - but it would keep me up at least one night out of each week.

I'm not going to address that mega-question today. But it is a central question I will be addressing in this space throughout 2012.

I will say this today though, although I've seen some considerably promising improvements at Fresh & Easy since Philip Clarke took over as CEO of Tesco in March of this year, the jury is still out on the central question I posed above, which is if Fresh & Easy Neighborhood Market is a viable - defined as something that can make money and be grown beyond its current three state geographical area - business for Tesco in America.

Stay tuned for that discussion in 2012. See you next year.

- The Insider

Related Stories

December 8, 2011: Tesco Reports 11.9% Q3 Comp Store Sales Gain for Fresh & Easy ... But On Heavy Discounting

November 10, 2011: Chief Marketing Officer Uwins Out in Top-Level Reshuffling at Tesco's Fresh & Easy Neighborhood Market

October 10, 2011: Gov. Signs AB 183: End of Self-Service Checkout Only in California For Fresh & Easy Neighborhood Market if Stores to Still Sell Alcohol

July 1, 2011: Tesco Shareholders Meet: Board Says Yes to Pay Plan, No to Investigation of Fresh & Easy Neighborhood Market; Pig Farmers Say it's Impossible to Bring Home the Bacon

May 11, 2011: CEO Philip Clarke Launches A New 'Vision and Strategy' For Tesco

February 28, 2011: Changing of the Guard: Clarke Takes Over the Reins as Tesco CEO Wednesday

February 23, 2011: 'The Insider' - Incoming Tesco CEO Philip Clarke Visits America - And Fresh & Easy Neighborhood Market

January 27, 2011: Incoming Tesco CEO Philip Clarke Names Expanded Corporate Executive Committee

October 8, 2010: 'The Insider' - Incoming Tesco CEO Philip Clarke Needs to 'Imagine' When it Comes to Fresh & Easy Neighborhood Market USA

October 5, 2010: Philip Clarke's Early Welcome to America: Tesco Logs $151 Million Half-Year Loss For Fresh & Easy Neighborhood Market

October 4, 2010: Tuesday's Tesco Interim Report Offers A Road Map of Sorts For the Future of Fresh & Easy Neighborhood Market

September 13, 2010: 'The Insider' - Reading Philip Clarke's Tea Leaves: Might A Mixed Corporate/Franchise Model Be in Fresh & Easy Neighborhood Market's Future?

June 12, 2010: 'The Insider' - Will Phil Clarke Shake Things up at Fresh & Easy Neighborhood Market USA When He Becomes Tesco CEO in 2011?

June 8, 2010: Tesco CEO Terry Leahy Retiring; Philip Clarke New CEO; Tim Mason Named Deputy CEO But Will Remain Fresh & Easy Neighborhood Market Chief in U.S.

[Readers: Click here to read past columns by 'The Insider.'


James Sinclair said...

Yes, theres a lot of competition existing and arriving, like the small walmarts and the winco expansion, but I think its traditional stores like Albertsons, Savemart and Vons that need to worry most, not Fresh and Easy.

Fresh and Easy can hit them on convenience, and Winco/WalMart/Target can hit them on price, leaving them with no niche of their own.

Anonymous said...

As an individual investor in Tesco I obviously want Fresh & Easy to be a big success. But strategically it doesn't make sense to me for Tesco to be in the U.S. The $2 billion or so invested in Fresh & Easy so far could have been far better spent in Asia and other less mature markets. But Phil Clarke inherited the U.S. so success is really his only option.