Retailing

Tesco Hits Record Profit, But Lags in U.S.


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British supermarket giant Tesco (TSCO.L) shrugged off the global recession to post annual revenues up 13%, to $79 billion, and pretax profits that blew past the magic £3 billion mark ($4.4 billion), up 5.5% from the previous year. But even as it unveiled the highest profits ever recorded by a British retailer, Tesco—ranked No. 3 in the world behind Wal-Mart (WMT) and France's Carrefour (CARR.PA)—was forced to concede that it finds doing business in the U.S. not so easy.

After all, last year was when Tesco's much-heralded U.S. venture, Fresh & Easy, was supposed to take off. Instead, the West Coast chain of midsize food markets posted higher-than-expected losses for the year ended Feb. 28 of $206 million, up from $90 million the previous year. Prospects of achieving breakeven even this year look increasingly remote.

Ever the optimist, Tesco Chief Executive Terry Leahy claimed that despite the losses, he was pleased with the chain's progress. "Clearly nobody would have chosen to open into the recession that we've seen there, which is particularly stiff in the Western U.S., but the customers love the stores, and it appeals right across the income range, right across the age range, and that bodes very well for its long-term appeal," he said in a statement.

Back home in Britain, where Tesco is the country's largest retailer and commands a third of the supermarket trade, it has successfully combated the recession by slashing prices. That has helped it maintain market share among penny-pinching shoppers, even in the face of increased competition from such discounters as Wal-Mart's Asda chain and Germany's Aldi. Tesco introduced a new "Discounter" range last September, which Leahy says is performing better than expected. "These products have been specially developed so that we can sell, at a lower price, a very good product but at a planned margin," Leahy said.

Banking Angle

Tesco also is benefiting from its continued push into banking. The group's financial operation, Tesco Personal Finance, has prospered from the economic crisis as British consumers pull their money out of the country's troubled banks. Since last fall, the unit has seen a near-doubling of savings balances, to $6.6 billion, as of the end of February. Tesco, which bought out former partner Royal Bank of Scotland (RBS) last December, plans to open 30 bank branches in its stores by the end of this year. Leahy seemed to confirm Tesco's ambitions to push more aggressively into full-service banking. "We believe that we've got a good opportunity to grow that business…with the Tesco customer base, and we can have a bigger, better banking business," he said.

Still, discounting is taking a toll on Tesco's profit growth. The 5.5% uptick reported on Apr. 21 was the slowest in 15 years—and far less than the 11.8% posted a year earlier. At the same time, Tesco is feeling increased pressure from rival British chains Wm. Morrison (MRW.L) and Sainsbury (SBRY.L), which saw full-year sales rise 7.9% and 4.5%, respectively, vs. growth of just 4.3% in Tesco's like-for-like British sales.

That's one reason Tesco, which already operates in 14 countries around the world, is pinning so much hope on success in the U.S. Since opening its first Fresh & Easy outlet in Los Angeles in November 2007, Tesco has unveiled 115 more in three main areas: Southern California, Las Vegas, and Phoenix. But that's a lot fewer than it once hoped. The company now says it's aiming for 200 stores by November of this year—50 fewer and almost a year later than originally planned.

In the Teeth of the Recession

Leahy says losses were always anticipated as the company undertook high upfront investments for the Fresh & Easy rollout. But the severity of the U.S. recession has clearly made matters worse. "We opened up into a pretty stiff downturn rather than into a growing economy, and that meant that we haven't been able to accelerate the openings as we planned," he said.

What's more, he argues, Fresh & Easy's unusual attributes—smaller stores, heavy reliance on house brands, and a tilt toward healthier food—represent "a new and different form of retailing" that may take time to catch on in the U.S. But some analysts are dubious. "It has hardly set the world on fire," says Jim Hertel, a managing partner at retail consultants Willard Bishop in Barrington, Ill. "The reality is, every food retailer of any size is experimenting with small formats." Indeed, Tesco faces increasing competition in the U.S. from Wal-Mart, which recently launched a small-format chain called Marketside, and from Aldi, which operates 1,000 stores in 29 states, including its popular Trader Joe's chain.

The British giant is discovering that the model that serves it so well at home isn't proving as popular across the Atlantic. In Britain, Tesco has mastered the art of private labels, with house-brand product lines covering every segment of the market, from its upscale Finest range to its newly introduced budget items under the Discounter label.

The problem is, Tesco remains relatively unknown in the U.S., so its private label products haven't achieved the same stature as, say, Trader Joe's. Analyst Hertel blames an "inconsistent merchandising strategy," in which Tesco prices some of its own-label goods, such as pasta sauce, at a 20% premium to better-known brands, such as Ragu. "This creates cognitive dissonance for the American consumer, who is used to seeing private labels cheaper than other brands," Hertel says.

If the recession drags on and losses continue to rise, will Tesco stay the course in the U.S.? Leahy maintains he's in it for the long haul. But if Tesco wants to reach breakeven in the U.S., it will need to work on both merchandising and marketing while continuing to invest in new openings to get the scale needed to move from the red into the black.

Capell is a senior writer in BusinessWeek's London bureau .

Kerry_capell
Capell is a senior writer in BusinessWeek's London bureau

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