On the Heels of the Global Retailer's Fiscal Year Financial Report, Investment Bank J. P. Morgan Issues Critical Investment Note on Tesco PLC

Investment bank J. P. Morgan yesterday issued a less than positive investor note regarding United Kingdom-based Tesco plc, which owns and operates the 116 small-format, combination grocery and fresh foods markets in California (Southern and Bakersfield), southern Nevada and Metropolitan Phoenix, Arizona.

Tesco is the third-largest retailer in the world, after number one U.S.-based Wal-Mart Stores, Inc. and number two Carrefour Group, which is headquartered in France. Tesco also is the leading food and grocery retailer in the United Kingdom.

In the investor note, J. P. Morgan said Tesco's overall market basket pricing (everyday store prices) in the UK market is too high relative to its top competitors, which are Wal-Mart-owned Asda, Sainsbury's and the Morrisons supermarket chain, often collectively referred to in Britain UK as the "big four" supermarket chains."

Additionally, J. P. Morgan said in the rather critical investor note that Tesco-UK's promotional and related programs are "too complex," and that the retailer is making a mistake by letting "the margin dictate the strategy."

The investment bank's analysis was prompted in part we believe by quarterly UK market share numbers that were released on April 1, which found Tesco losing share to top rivals Asda and Morrisons, something the UK's leading supermarket chain has been doing for about a year.

Tesco continues to lose market share to rivals Morrisons and Asda, according to Nielsen data for the 12 weeks to March 21.

Sales in the UK food and grocery sector grew at 2.7% year-on-year in the first quarter of 2009, with the grocery multiples faring slightly better (up 4.4%) over the same period, according to Nielsen Scantrack data released on April 1.

Of the "big four" UK supermarket chains (Tesco, Asda, Sansbury's and Morrisons), Morrisons leads the pack with 6.9% year-on-year sales growth, followed by Asda (up 6.7%). Tesco continues to lose market share with almost a half percentage point decline to 27.6% for the quarter, with Asda and Morrisons each picking up 0.2 points, according to Nielsen.

Tesco's current market share in the UK is 30.4%. That's down from about 31.6% a year ago.

Asda and Morrisons, along with small-format, hard-discount retailers Aldi and Lidl, have been steadily taking share away from Tesco for about one year in the UK.

But at 30.4%, Tesco remains hands down the leading food and grocery retailer in Britain. For example, number two Asda has about a 17.6% overall share, while number three Sainsbury's has about 16%. Morrisons is the nation's number four market share chain. It has an about 12.5% total share of UK food and grocery sales.

Despite this fact, that Tesco retains a huge market share lead, the loss of share is a major concern for Tesco, or at least should be. In the high volume, low margin supermarket business, every share point represents lots of lost sales. And the fact key rivals Asda and Morrisons continue to take share away from Tesco on what now seems to be a regular basis should be serious cause for concern because its ongoing rather than sporadic share erosion.

Tesco plc is set to report its full fiscal year financial results later this month.

The critical report issued last week from J. P. Morgan, coming just prior to the annual end of the fiscal year financial reporting, isn't a positive development for Tesco.

Tesco's growing corporate debt

The investment bank also offered a critical analysis on Tesco's overall corporate debt position.

J. P. Morgan said it believes Tesco's debt will exceed its targeted amount of £8 billion (pounds). The global retailer also has a current corporate pension fund deficit of £838 million (pounds). In its note, the investment bank says it believes the pension fund deficit has soared to £2 billion (pounds).

The investment bank's analysts paint the added debt loads in rather negative terms in the investment note.

Fresh & Easy USA

J. P. Morgan also sounds an alarm in its investment note over Tesco's U.S. Fresh & Easy Neighborhood Market food and grocery chain. The investment bank predicts Fresh & Easy will post a loss of £100million (pounds) (about $150 million) in the next fiscal year.

Fresh & Easy Buzz basically agrees with that number, although we actually think Fresh & Easy's loss could be a bit higher than the £100million (pounds), or about $150 million.

Further, we don't see any signs that Tesco will stop burning cash anytime soon with Fresh & Easy, although it is conserving some cash by postponing new store openings and its launch into Northern California.

Margin issue

We aren't sure about J. P. Morgan's argument that Tesco is letting margin rule its strategy in the UK. While it is true the retailer has lost about one full point in market share to its key rivals over about the last year, in the grand scheme of things it isn't clear to us that reducing margins, which is the implication of the J. P. Morgan argument, would (1) have stemmed that market share loss and (2) been worth it even if hypothetically the result of a significant margin reduction would have been say losing only half the about 1% market share amount over the year.

Margins matter; even in a recession. A significant percentage of Tesco's market share loss over the last year has come from the German hard-discount grocer Aldi-UK, which operates a no frills, low price-focused model. We doubt margin reduction for Tesco would have stopped this. Aldi is fast-growing in the UK. However, because of its relative small store count in Britain is has only about a 3% overall market share, which is excellent for the number of stores the grocer operates in the country.

Another significant percentage of the market share loss comes from Wal-Mart-owned Asda, which is a discount-focused operator. While we think some margin reduction by Tesco might have prevented some share loss to Asda, it's important to note that Asda is doing lots of correct things these days in the UK market, and therefore market share is a logical result of the supermarket chain's excellent merchandising and operations performance over the last two years.

And Morrisons, which has been the leading gainer among the UK's "big four" supermarket chains for sometime, is on a roll; it seems to be doing everything right. Would margin reduction by Tesco, resulting in lower everyday prices in its UK stores, have been enough, or will it be enough, to stop Morrisons' roll? We doubt it.

Interestingly, Tesco has been reducing margins at least a little bit of late. It has to be because the retailer has been lowering everyday prices, putting greater emphasis on a lower margin discount store brand, and offering far deeper price promotions than it has in the past in the UK.

We suspect further price reductions are in store for Tesco as well. It will likely do what it has to to stem the market share loss in its home UK market, which represents a very high percentage of the company's overall annual sales and profits.

Fiscal year financials

But Tesco's release of its fiscal year financials later this month will help make more clear the margin issue. If profits are good, margin reduction as a way to stem the market share loss the retailer has been experiencing, will take second or third fiddle, in our analysis.

This month's annual financial report for the fiscal year ended on February 28 will also offer a better quantitative analysis of Fresh & Easy Neighborhood Market USA, although don't expect to see Tesco break out extensive, detailed financials for Fresh & Easy.

[Readers: You can follow Fresh & Easy Buzz around on Twitter.com at www.twitter.com/freshneasybuzz.]

Andy Bond, CEO of Wal-Mart-Owned Asda in the UK, Offers His 'Two Pence' Worth On the Pre-Christmas, Deep-Discount Festival Promotion By Tesco-UK

Asda CEO Andy Bond, in one of the chain's UK supermarkets, says he wants to "rock" the British food and grocery retailing business. He has parent company Wal-Mart Stores, Inc.'s resources and support behind him to do so. (Photo credit: This is Money-UK.

Retailing News From Across the Pond

Yesterday, we reported in this story [Tesco Slashing Prices By 50% on 1,000 Items For Four Days in its UK Stores; Will We See A Similar Promo at Fresh & Easy USA?] about a pre-Christmas holiday promotion Tesco, which owns and operates Fresh & Easy Neighborhood Market in the Western USA, started today in which the retailer is slashing the prices on 1,000 food, grocery and gift items in its United Kingdom stores by 50%. The 1,000 item, half-price promo ends in Sunday.

Tesco's big price slashing promotion comes on the heels of similar pre-Christmas holiday promotions already conducted by UK food, grocery and general merchandise retailer Marks & Spencer (M&S) and the British department/general merchandise chain Debenham's. Tesco and the other retailers are trying to stimulate holiday sales, both on food, drink and grocery items, but even more importantly on general merchandise and gift items for Christmas.

Today, the day after our report and the day Tesco's 4-day, 1,000 items half-price holiday promotion started, Andy Bond, the CEO of Wal-Mart Stores, Inc.-owned Asda, the number two retail chain in the UK after number one Tesco, offered a blistering attack at retailers (he didn't name names but who he meant is rather obvious) who are doing such limited item, price percentage slashing pre-Christmas promotions.

Bond made his comments, which are worthy of the aggressive offensive action expressed by his namesake, British secret agent 007, James Bond, in the movies, in the UK's Independent newspaper today.

Wal-Mart-owned Asda has been focusing on an everyday, deep discount merchandising and promotional program for most of this year, and the chain intensified its discount merchandising model a few months ago as the financial crisis and recession hit the UK hard.

Asda's program has paid off for the chain this year. It's increased sales and gained a tiny percentage market share on rival Tesco and number three food and grocery chain Sainsbury's. Asda currently has about 17% of the UK market to Sainsbury's about 15% Tesco though is head over heels above both Asda and Sainsbury's when it comes to market share. It has an about 31% share of the UK food and grocery retailing market, nearly equal to what Asda and Sainsbury's control combined.

However, Tesco also is losing share to the small-format, deep discount chains Aldi, Lidl and Netto in the UK. Asda is holding its own against these smaller store rival discounters in terms of gaining a small overall share rather than losing any.

Below (in italics) is what Asda CEO Andy Bond had to say about those "no name" UK chains that are launching 4-day, limited items percent off promotions (aka: Tesco M&S and Debenhams).

UK: Asda boss takes swipe at Tesco discounting
The Independent.co.uk

The boss of Asda yesterday attacked the massive pre-Christmas discounts offered by his rivals, in a thinly-veiled swipe at retailers such as Marks and Spencer, Debenhams and Tesco.

Andy Bond, the supermarket chain's chief executive, said: "There are lots of struggling retailers who are confusing customers with 20 per cent off this day, 50 per cent off that day. That will stimulate sales in the short term, but that will not be the way to grow a business in the economic downturn.

"However, Mr Bond declined to name any specific retailers.

His comments came as Tesco said it would cut the prices of 1,000 products, including Christmas food, drink, toys and gifts, by 50 per cent this weekend.

Earlier this week, Debenhams launched its third three-day festive sale, with 20 per cent off many items.

M&S introduced further pre-Christmas discounts yesterday, after holding two one-day sales held in recent weeks.

Mr Bond criticised such hefty promotions as "gimmicky" and claimed that they sowed the seeds of "mistrust" among shoppers. Big sales days were "a horrendous way to run a retailer", he suggested. However, Asda has also held some significant one-off price promotions this year, particularly during the summer when it cut prices on selected items for a few weekends.

Mr Bond said Asda, owned by the US supermarket group Wal-Mart, had no intention of launching a range of discounted brands, such as those introduced by Tesco in September.

"It offers confusion rather than clarity," he said. "Adding a fourth tier to your brand hierarchy – I just don't get it."

Asda revealed that the sharp slowdown in consumer spending had led to radical changes in shopping patterns. For instance, customers are buying smaller portions of food, such as Christmas pudding, and pack sizes, as well as scrutinising sell-by-dates and purchasing more frozen food as they seek to reduce wastage. Mr Bond also said his customers were increasingly cooking from scratch and switching to Asda's cheaper own-brand products.

Asda said sales of hair dyes were up 27 per cent as customers cut back on trips to hairdressers. Sales of curry ingredients had jumped by 40 per cent in the past year, balsamic vinegar had risen by 70 per cent, olives were up by 50 per cent and champagne rocketed by 100 per cent as shoppers shunned restaurants to cook and entertain at home.

The doubling in sales of champagne at Asda also suggested that consumers were seeking value for money and the grocer was attracting more middle-class shoppers, Mr Bond said.

However, sales of some ready meals had fallen by 40 per cent as customers attempted to save money by cooking their own meals.

Mr Bond said he believed the current downturn would lead to a new generation of British consumer, who was more focused on cutting waste, seeking out low prices and spending more time entertaining at home, such as with Nintendo Wii consoles.

He added: "We are moving into an era of the frivolous being unacceptable and the frugal being cool. It won't be everybody, but there will be a type of consumer that will be defined at this moment that will stay with us for a long time."

[-end Independent piece-]

U.S. retailers seldom offer their opinions of the competition let alone go after their practices and programs. That is one of the many reasons we do enjoy the British food and grocery retailing industry.

Now, we just need to hear from Mark Price, the CEO of the UK-Waitrose supermarket chain, which is from a competitive standpoint the hard-charging number two (the upscale food retailing segment) to Marks & Spencer, as Asda is the hard-charging number tow to Tesco.

Of course Price is an equal opportunity fun poker. He loves going after M&S chairman and CEO Sir Richard Rose, who Price calls "The King of Pants" (M&S sells lots of its own brand clothing, along with food, groceries and lots of other things, and its men's pants were named the best quality in the UK this year). The men are friends as well as competitors.

Price also loves digging Tesco CEO Sir Terry Leahy, as well as Asda's Andy Bond. In fact, if one is a CEO of a British food and grocery retailing chain and hasn't been the subject of one or more of Price's jabs in the UK press, or in his own Blog on the Waitrose Website [www.waitrose.com], then there must be something wrong with them.

More "Retailing News From Across the Pond" at the links below:

Stories from the UK press from December 11-12, 2008:

>UK: Tesco And Waitrose Lose Market Shares As Grocery Sector Continues To Slow
>UK: Low-cost supermarkets enjoy boosts
>British retailers brace against downturn
>UK: Somerfield ends independence with sales fillip
>UK: Waitrose suffers first sales drop in 5 years