A man walks past a Tesco store in south London October 23, 2014. Tesco reported a bigger than expected hole in its finances on Thursday after finding accounting mistakes had gone back further than initially thought, forcing Britain's biggest grocer to scrap its full-year profit outlook.PAUL HACKETT/Reuters
Forget cleanup in aisle one. Every aisle of Britain's Tesco PLC, the world's second-biggest supermarket company, needs the mop and pail treatment.
Tesco has been delivering bad news to investors for more than a year. Philip Clarke, the chief executive officer, lost his job in July. A real shocker came two months later, when the company revealed a profit overstatement of £250-million ($450-million), later increased to £263-million. The shares plunged and investor confidence shattered like dropped eggs.
The shares fell again on Thursday, when Tesco reported first half, after-tax profits of £112-million, including £527-million of one-time charges, against a profit of £1.39-billion in the same period a year ago. Same-store sales fell 5.5 per cent. The 6.5-per-cent share-price fall took the one-year loss to 54 per cent, pushing the company's market value down to £14.9-billion, an 11-year low.
Moody's topped off a bad day by handing Tesco a one-notch downgrade. Another downgrade would thrust it into junk status.
The disastrous performance cost chairman Sir Richard Broadbent his job on Thursday. The new CEO, Dave Lewis, who replaced Mr. Clarke at the start of October, faces Britain's biggest turnaround effort. Tesco is a big, ungainly beast in a hyper-competitive market and analysts are warning investors that the time for bargain hunting has yet to arrive.
Even Warren Buffett bet on Tesco. Earlier this month, the man who rarely gets his investments wrong called his Tesco purchase a "huge mistake" and cut his 3.97-per-cent stake to less than 3 per cent.
Tesco is also a victim of arrogance, an overly ambitious international expansion strategy and an awkward market position that pinned it between the ever more popular discounters, such as Germany's Aldi, and the upmarket Waitrose chain. A recent survey revealed that more than half of shoppers went to a discounter in the last month, a four-year high.
It was also a victim of changing consumer preferences. Big box, suburban supermarkets – Tesco's specialty – are losing favour as the cost of driving goes up and time constraints mean parents can't devote entire Saturday mornings to the big weekly shop.
There was a time when Tesco could do no wrong, which is why it attracted long-term value investors like Mr. Buffett. A big factor behind its success was reliably high food inflation, which averaged almost 3 per cent a year between 1989 and 2014. Rising prices boosted profit margins. They also created room for the discounters, who came on strong.
Food inflation recently turned negative in Britain as the sterling rose, commodity prices fell and competition intensified. Tesco's easy way out – raising prices – is no longer an option.
The financial state of the British consumer played a role in Tesco's downfall too. While the British economy is growing, it has only now reached precrisis levels. The slow recovery has held back consumer spending; disposable income is still 2.6-per-cent per capita below its 2007 peak.
Tesco faces a monster cost-cutting and repositioning program to meet the new market realities. The effort won't be easy as the competition smells blood and ramps up pressure. The new boss will have to brace investors for a long, agonizing turnaround effort.
Eric Reguly