Tesco Earnings Call Insights: Outlook and Details for European Markets

Tesco (NASDAQ:TESO) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

Outlook and Details for European Markets

Philip Clarke – Group Chief Executive: This wouldn’t be one of these meetings that you’re asking questions about Tesco Direct.

Philip Dorgan – Panmure Gordon: No.

Philip Clarke – Group Chief Executive: The reason I’m pleased with Q4 is that we had a really good Christmas and did a great job for customers and then in January and February, we didn’t feel the need to (blast) coupons around to win back trade. So we’re pleased with the way things went at Easter. The most important thing is the way customers are reacting. It’s always going to take a bit time in this because you know you can see from the graph below shows like-for-like wasn’t exactly going in the right way for quite a while and now we’ve stabilized it and we’ve got so much more that we know that we can do in 2013. It could have been very, very different. On the European markets, 300,000 square feet in Poland…

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Laurie McIlwee – CFO: Yes, one important context, I think, two years ago or 2011, ’12, we were opening 2.7 million square feet in Europe. We dropped that to 1.4 million in the year just gone and we’re moving to 400,000 square feet for the whole region in the coming year, including Republic of Ireland and Turkey. So, that’s a fairly major cut into the new space that’s going into the market. Your specific question about Poland, we opened, I think, about 190,000 square feet in Poland in hypermarket, it was three hypermarket, which we already committed to. So we had to open, they’re actually trading pretty well and they have been sized more appropriately than 120,000, 100,000 square feet hypermarkets we’ve opened in the past. The coming year is 400,000 for the whole region, most of it going into smaller formats.

Philip Clarke – Group Chief Executive: On Tesco Direct, well, it doesn’t make any money, you know, we’ve never said how much. The reason it doesn’t it’s not got to the scale and the reason it hasn’t got to the scale is our general merchandise offer hasn’t been good enough in the U.K. I am disappointed with the general merchandise performance last year. But we have really gripped it now and my sense is that it’s about to improve and I set out the GM strategy when I was talking about the hypermarket strategy for the U.K. So, you can see where it’s all heading. I think people, customers in particular will begin to respond very positively to GM in stores and then that will help us to do a better job online. So, I am sorry I am not going to give the losses, I never have I disclosed, enough is there already. Another question, let’s look over here…

Jerome Samuel – HSBC: Jerome Samuel, HSBC. A question on the U.S., so you confirmed already the future exit, what kind of timeframe can we expect? More important, the cash impact of that exit you expect?

Philip Clarke – Group Chief Executive: Laurie is leading the process and the negotiations for us. So Laurie, do you want to just say a few words about that?

Laurie McIlwee – CFO: Yeah. You’ll appreciate, there is a lot of commercial sensitivity around the process that I am right in the middle of. So just two weeks ago, we received the first set of indicative offers from prospective buyers. It did generate a lot of interest. Encouragingly, there are a number of organizations that want to buy the business in its entirety or virtually in its entirety. So those are ones that we are pursuing with earnest. It’s hard to put a specific date on when the process will be complete, but it won’t be within the next three months. So, we should kind of mentally target that as the first, if you like, deadline. Then importantly, the end of your question, the indicative offers that we have received will mean that we will be getting out of the U.S. without any further cash investments into the U.S. to exit. Of course, we do make a trading loss. So we’ll have to support the trading loss from now until we actually sell the business.

Jerome Samuel – HSBC: Philip, on international. International excluding the U.S. represent about 35% of your Group profits now. Do you expect it to increase medium-term or given what you said, you think it’s going to plateau at this level?

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Philip Clarke – Group Chief Executive: I think we have been pretty clear in terms of our expectations in the financial guiderails to say that Europe is going to be at the low end of single-digit growth and Asia is going to be at the higher end of single-digit growth, and ex-one-time effects, like the annualized effect of (indiscernible) in Asia, but also the historic one-time issues I mentioned in my speech in Turkey and the crisis tax in Hungary that’s going to be the shape of those two regions.

John Kershaw – Exane BNP Paribas: John Kershaw from Exane BNP Paribas. Just a couple, on the return sides, first of all, thanks for the welcome calendar on that, but in terms of if it is going to be more capital discipline, less CapEx, are you not still in too many markets, because you know well that you need to fight for leadership to drive those returns. So could we not expect perhaps market exits to come, give us some more color on that and then in terms of the guide rails, 12% to 15% is that a case of down before up because of the tough macro and a bit more to go or is it a new realization of multichannel returns will be lower in aggregate for the Group? Then finally, given that you touched on Q4 trading just more broadly, can you put some numbers to online profitability because it’s clear that your future you’ve given us what we sort of knew already, what we are looking for is numbers as you know as we (indiscernible)?

Philip Clarke – Group Chief Executive: Market exists; we’re out of the markets. I didn’t think we’d be able to provide a right blend of growth in returns that I want to deliver for shareholders. I don’t believe it will be necessary to exit any others. The European markets are perhaps the most challenging for reasons that it’s the first time those consumers have actually felt recession since the end of communism and rising unemployment and everything that you know about austerity, but two of them are market leaders with more than 25% share of the market. Two of them are second or third in the market, in markets that have really been hit very hard, and one is Turkey which you put into the third grouping. We’re not putting a lot of capital behind Turkey until we find a model that we think can win. Again, in the (sake of Canada), we are disappointed with your in part the economies hasn’t helped, in part we haven’t helped ourselves and are receiving considerable attention at the moment for that reason. The fact that Czech, Poland and Slovakia, Hungary are contiguous, you’ve heard us talked often I think about getting some more synergies out of it. Well, we’re absolutely on that as we speak. Laurie is going to take the guide rail question about ROCE and then I’ll just finish on Q4 trading.

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Laurie McIlwee – CFO: So the guide rails, John, that 12% to 15% as you imply, we’re already above the bottom of it at 12.7% and it’s our intention and our planning assumption in balance with controlling capital and getting mid-single digit growth in earnings. The returns will gradually tick up over time, so not going back.

Philip Clarke – Group Chief Executive: So, in the Q4 trading caution, we’ve got to what is the grocery home shopping profitably I think, well, it is profitable, but I’m not going to give the number today. We keep being asked this question, so at some point, we’re going to have to, but we will do it at the right time and when we’re ready for it, and we’ll think about the implications of that. The Central European businesses, which have only been running for seven months are already breaking even at cash level. The U.K. does much better than that much, much better than that. Another question, we go right to the back if we may. Thank you and then I’ll come back towards the front…

James Grzinic – Jefferies: It’s James Grzinic from Jefferies. I had two. The first one was, just looking at Page 63, you seem to assume that there will be a big balance in operating cash flow already from this year. Can you help us it looks about GBP1 billion what are the component parts of that? How much of that is working capital non-repeat, so exceptional is how much is Fresh & Easy and perhaps so you can tell us how much for a negative Fresh & Easy was in the past year? In terms of space plans for the U.K., you’re still going to put down 700,000 square feet of extra space, hypermarket space this year. Is that mostly reflective of contractual obligations? Should we expect that to go down drastically? You have the next?

Philip Clarke – Group Chief Executive: While we’re trying to find Page 63 and Chris is about to do.

Chris Bush – MD, U.K.: I’d rather go James in terms of the operating cash flows.

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Philip Clarke – Group Chief Executive: He wrote the book. Thank you very much. I’ll just do the 700,000 square foot of extras and what’s going to happen in the future. I’m going to do that.

Chris Bush – MD, U.K.: Let me do it firstly.

Philip Clarke – Group Chief Executive: Well, if you’ve got the answer, yeah. I was giving you some time.

Chris Bush – MD, U.K.: If you can give me 30 seconds, I think it will be very helpful.

Philip Clarke – Group Chief Executive: Good. (multiple speakers). He still can’t find 63. Anyway, if (indiscernible).

Chris Bush – MD, U.K.: (Indiscernible).

Philip Clarke – Group Chief Executive: Yeah, so it will be hard for people to believe that Tesco has places in the U.K. where it doesn’t have a presence, but it is true and someone is going to sneak in when I say press that in our market share and press that in, was about 1 or 2 (technical difficulty) open the food superstore there with the clothing department nine weeks ago. The stores that you’re seeing us open in this year and in future years are going to be in places where we don’t have a store or the store that we have isn’t fit for the future. So let’s just think about Sunderland. I know people know nothing much about Sunderland, but some of us unfortunately have to, Sunderland has a metro and obviously R&D in the north of England, we had 10,000 square foot metro, which is what we have today, we are opening a center of town hypermarket, Gateshead, 35,000 square foot store opened 35 years ago, we are closing it. We are opening a new extra 70,000 square feet flat-free car parking and so on. So the extras are in places where we are not. Some of them are replacement. So upgrading an existing store that isn’t competitive or positioned nicely for the multichannel opportunity and in future years that’s what you’ll see us do. But we won’t be opening 2.5 million square feet even, they’re not going to be 150,000 square feet, they’ll be more like about 75,000 to 80,000 square feet and there will be fewer of them. I think what we’ll do in future communications (indiscernible) which the stores are and then you’ll all see the perfect sense of it in a way. So now if you got to Page 63

Laurie McIlwee – CFO: I have. Sorry, James, we mostly confuse ourselves, because we had a different numbering on the charts than the book that you’ve got, and of course I know Page 63. I think it’s first important in context to explain the operating cash flow for the retail business this year, so you can understand what grows next year. So the trading performance of the Group did go backwards and that took about GBP0.5 billion, GBP500 million of our cash flow year-on-year. Then working capital for the retail business, which I’ll come back to, declined by about GBP500 million and then we paid about GBP200 million into the pension fund, so that was a GBP1.2 billion outflow for the retail business. Now, of course, our intention is to grow next year so we don’t have the drag of the retail business going backwards and we intend to improve our working capital going forward and we don’t need to pay another payment into the pension. There is a related question, why did working capital go backwards in the year. Actually our stock performance was fine, but our creditor performance did decline. There were two key impacts here. The first was to try and reduce stock, and as I say we didn’t, we moved some of our general merchandise sourcing from long lead time Asia to shorter lead time in Europe and that did reduce the lead time, it also reduced the creditor days but it didn’t reduce the stock. So we had a degradation in our creditor days for that. The second area is a little bit more sensitive, because I don’t want to refer to specific countries, but there’s our country in Asia and there are certain countries in Central Europe where the regulator is very focused upon organizations trying to extend their credit terms, in fact put pressure to reduce it. We’d comply with that. Importantly, and I know this is irritating for you, but the most important thing for me to do on working capital is to improve it all the way through the year, not when I report back to you. So, actually, because that’s the thing see obviously that drives the overdraft to the bank and that’s the thing that drives the interest. Now, importantly, the working capital performance through the year was much better than in the prior year. In fact our outflow on average was flat. We didn’t have an outflow on average. It was just a poor performance at the end of the financial year than we were planning. So we should see an improvement in working capital. Indeed, it’s a great focus for all of our businesses in the coming year and we should shoot see trading profit performance growth, and that’s the thing that starts to make the cash flow growth with the same level of CapEx.

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James Grzinic – Jefferies: And just to clarify one question easy is the consolidated out of the cash flow. How much of a drag are you taking out of the operating cash flow, because this presume over the past year would have been strongly negatively even if you reduce CapEx?

Laurie McIlwee – CFO: For the U.S. yes, a couple of hundred million pounds.

Sreedhar Mahamkali – Macquarie: Sreedhar Mahamkali from Macquarie. Three questions there please. Firstly, are you now comfortable that the U.K. recovery is fully on tract and that you are actually reporting positive like-for-likes through the year in the context of something 1% like-for-like in consensus, driven by food of course. That’s the first question please. And secondly, can you talk a little bit more about non-food particularly profitability in the context of U.K. margin, is it how dilutive non-food is and what can you do there? And in the context of non-food again, on Slide 64, I’m not sure what slide number that is on your pack. On Slide 64, where you talk about resetting the space. There is no reference to electricals on that chart. How much space is that in electricals and is that all going to disappear and finally losses in Turkey?

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