Credit: C41n/Wikipedia

Is Tesco over the worst?

Profits halve at the embattled retailer, but the long retreat may be coming to an end as its sales decline slows.

by Adam Gale
Last Updated: 26 Jan 2016

Dave Lewis is 'quietly confident' that Tesco's worst days are over. The retailer's not-so-new-anymore boss revealed the rout in group sales has now slowed to a manageable retreat. In its second quarter to August 29, Tesco's like-for-like sales in the UK were down a mere 1%, compared to 4% the same time last year.

Transactions, on the other hand, were actually up 1.4%. That's right - we're now buying more stuff from Tesco. If that refreshing news isn't reason to celebrate, what is?

Yes, underlying first half profits fell 55% to £354m, but this is no time to lose focus on the positives. 'We have delivered an unprecedented level of change in our business over the last twelve months and it is working,' said Lewis. 'In the UK, we continue to improve all aspects of our offer for customers, resulting in volume growth which is allowing us to create a virtuous circle of investment.'

You can't beat a good 'virtuous circle', eh. Lewis was brought in to clean up the mess caused by the previous management's failure (and they were far from unique in this) to anticipate the customer drift from giant, out-of-town supermarkets or the rise of the German super-low price retailers Aldi and Lidl.

Horribly overstretched and with some suspect accounting practices, Lewis' response was to cut costs (by shedding head office jobs, closing unprofitable stores and reducing its range), shore up the balance sheet (it recently sold its South Korean business Homeplus for £4bn) and slash prices to maintain market share. This strategy does appear to be bearing dividends (unlike Tesco shares, of course).

Sales are better than they were, the balance sheet is apparently strong enough that Lewis has said he doesn't intend to sell any more international assets (or Tesco's data business Dunhumby, but he didn't have much of a choice there) and the group is on track to make a £400m cost reduction for the full year as a result of its restructuring. All in all, it's vying with Sainbury's for the 'big supermarket closest to recovery' award (sorry Asda and Morrison's).

It's impossible of course to know what would be happening had Lewis not taken the job last year, but he does appear to be making the most of a bad situation. The problem is, the bad situation shows no signs of abating.

Aldi and Lidl aren't going anywhere and neither is their ability - rooted fundamentally in their business model - to undercut the likes of Tesco. Trying to keep up with them on prices to protect market share means permanently reducing margins and therefore profits.

Add Lewis' worries about the costs of implementing the National Living Wage next year (despite Lidl announcing it will be bringing in the higher, voluntary living wage), and it's not looking all that rosy. This isn't to say Tesco can't recover, of course. Indeed, that process seems to have begun already. But it's hard to envisage a recovery to where it was before its annus horribilis in 2014-15.

At the moment, investors appear content with Lewis stopping the rot (Tesco shares were up 0.6% by mid-morning to 193.4p).

Once the business stops feeling the after-effects of last year's shocks, though - are there are reports that Tesco might be set to settle the SFO's ongoing criminal investigation into its accounting 'black hole' in a US-style plea bargain - then shareholders' demands might become more ambitious and, unfortunately for Lewis, less deliverable.

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