United States - Tesco Fails To Attract Necessary Customers at US Division but Not Giving Up On Project Yet

04 May 2011 • by Natalie Aster

Tesco's latest annual results continue to point to difficulties at its US division Fresh & Easy. In the 12 months to February 26 2011 the division recorded a 38.1% increase in sales, which came in at GBP502mn. However, losses at the unit grew by 9.7% to reach GBP186mn (see first chart). The firm attributed the widening losses to costs associated with the integration of two suppliers and the company's CEO Philip Clarke has suggested that the firm should break-even towards the end of 2013. However, this fails to fully address what BMI sees as the wider problem of lacklustre revenues and not enough customers.

Tesco's CEO alluded to the problem of lack of customers by suggesting that the 'the ones who use Fresh & Easy really love it but we just need more of them and I can see quite a few things we can do to drive customer traffic'. There were some positive signs in the latest figures, with like-for-like sales in the US up by 9.4% during the year. However, a cursory analysis of the company's existing figures suggests its stores are still failing in a big way to draw in the necessary crowds.

Tesco now operates 172 stores in the country which means it opened 27 new stores during the year. We can attempt to estimate the average turnover per store by halving the number of stores opened in the year (which equates to all the newly opened stores being opened for six months) and subtracting the figure from the total number of stores. This gives us an average store turnover of 502/158.5 = GBP3.2mn.

Widening Losses

Fresh & Easy Results (GBPmn)

Source: Investor Relations

This is an improvement on the figures of recent years (in 2010 the figure came in at GBP2.72mn and in 2009 it stood at GBP2.49mn). However, it is well below the average sales per square foot achieved by existing US supermarkets and industry estimates suggest that Tesco needs to generate around US$10mn per store to be operating profitably, which still looks a very long way off.

Tesco's change of CEO gave it the ideal opportunity to draw a line under the US business and write it off as an expensive mistake made by the previous boss. However, the fact that the firm has not chosen to do this suggests that it really does see the business as having potential - even if that potential is currently difficult to recognise. This optimism is likely to be based partly on the brands positioning - which sits somewhere between a hard discount store and a convenient supermarket. These two formats are currently by far the fastest growing parts of the retail sector in the US (see second chart) and if Tesco does manage to ride this wave it could be set for very strong growth. However, whether the firm's positioning is simply too unusual to draw the crowds needed to operate profitability remains an unanswered question.

Convenience and Discount Growing Fastest

US Retail Sales

e/f = BMI estimate/forecast. Source: FedStats, US Department of Commerce, National Retail Federation, BMI

Tesco has suggested that business 'remains on-track to break-even towards the end of the 2012/13 financial year'. The firm also highlighted that 'with the improvements in our distribution centre and manufacturing campus productivity, resulting from the acquisition of the two suppliers, we now expect to reach break-even with around 300 stores trading, rather than the 400 we originally anticipated'. This would certainly be a positive result but it is almost certainly built on optimistic projections for customer growth at existing stores, which it is of course very difficult to predict.

The current level of losses is small beer in comparison to Tesco's group trading profit of GBP3.68bn. The company can therefore afford to continue to keep the business ticking over, while hoping that adjustments to its store offering and marketing deliver the required increase in customers. However, the fact that the firm only opened 27 stores in the year to February 26 and plans to open just 50 in the current year suggests the new CEO is still not fully convinced by the project, and could quickly pull the plug if plans to increase customer numbers fail to have the desired effect.

BMI’s food and drink reports feature a market assessment and independent 5-year forecasts for food and drink expenditure by product category, consumption, sales, imports and exports, and for the mass grocery retail sector. The reports also include analyses of latest regulatory developments, the background macroeconomic outlook, and competitive landscapes comparing multinational and national companies by leading products and services, sales, investments, partners and expansion strategies.

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