Tesco Earnings Call Nuggets: Margin Performance, Price and Value in the U.K.

On Wednesday, Tesco reported its first quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Margin Performance

Laurie McIlwee – CFO: As you say, during the prelims, we laid out pretty clearly the margin progression and stated actually that 5.2% was the operating margin for the first half. This is the new base, so we see a similar margin performance for the second half of the year. So if we get sales growth, there will be no margin deterioration, or a very little margin deterioration. So we should get back to a much better performance in terms of profit year-on-year in the second half than we’ve had in the first half.

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Philip Clarke – Group Chief Executive: I want to see us grow our profits in the U.K. in ‘13 on the back of sales growth. I think it’s very important we don’t take out too much. We put more back in for customers. So whenever we can, we will be doing that. But next year start to say no, that’s our objective.

Unidentified Analyst: A couple of questions for me. Can you talk a little bit more about what you’re doing on the general merchandise side, because you have given as an example of space reallocation and it looks like that’s progressing in quite a few stores? What’s the magnitude of this thing that you are trying to do here? What have been the results so far and what should we think about in a year, two years’ time? That’s the first one. Secondly, you’ve talked a lot about customer perceptions on service, quality, availability, et cetera. You have not talked about customer perception on price/value in terms of any metrics you can give us there, that’ll be helpful? Finally, just help us understand the 100 million Korean impact this year in terms of the dynamics, how that’s actually 100 million this year when really it’s only about six months or seven, eight months in terms of full impact of Sunday (indiscernible)?

Philip Clarke – Group Chief Executive: I’ll let Laurie take the question on Korea, but before he does that, there’re 500 or so stores in the U.K. that are superstores, these are the stores that opened beginning around the end of the 1980s all the way through to most recent times. We opened another superstore (new one) in the first half of the year. We also opened an extra in the first half of the year. Those stores were going to correct the amount of space that we put to general merchandise. When we do the Investor tour next month, we will take you to one and show you what we’ve done. I showed you in my introductory remarks. So that means more food, less general merchandise in the stores. We got quite a lot of clearing up to do in general merchandise anyway. We said a year ago, our range has got a bit tied. There is quite a lot of stuff that we’re working through. There are improvements coming to categories. We’re very, very big on traditional media, that’s where that investments come in to digital media because it’s falling about 25% a year. So I expect (NYSE:GM) to get back to positive like-for-like growth in 2013-2014. Online is where the big expansion in range will come. It’ll be contracting in our stores. On customer perceptions on price and value, well, there is just a bit of a dent in Q4 because for customers price and value it’s all about what’s the net cost of doing their shopping with so much couponing and that’s not playing hard. That was difficult. I think some competitors have done very well with their comparisons to us. It’s nice that they choose to compare themselves to us by the way. It’s stable. It’s not improving, but we have to see it start to regain something during the course of the next six to nine months because we got our own plans in that respect. But for us, building another Tesco is six part of the plan, not one part of a plan. What I don’t want to be and what we won’t be any more is just following slavishly somebody else’s agenda. We’re going to follow our agenda and then you see how that performs. You’ll see how it performs because our relative performance should at least start to get in line with the pack and then we expect it to do better in that. Already in food, it’s doing that. Yeah, already in food. So on to Korean 100 million only six to eight months, why so much?

Laurie McIlwee – CFO: So let’s be clear on the facts. So South Korea so far in the first half of the year, we’ve been closed five Sundays at all our stores. On a Sunday, we take 20% of our trade, some customers were adjusting to trade with us on other days. So we’re recouping somewhere between 20% and 30% of the 20% that we lose. So net 14%, if you like. It not only impact ourselves, but as you’ve been ran our South Korean stores, you know we’ve got a lot of tenants in there as well. So they’re effectively closed, we lose the tenant income. The second factor is the 24-hour trading. We’re one of the very few retailers in Korea that does 24-hour trading. Now we’ve not been able to 24-hour trade for 13 weeks. So combined those two effects, the Sunday trading hit us by about 2.9% negative like-for-like and the 24-hour trading about 1.5% negative like-for-like. So that’s the first half and of the 100 million to size it for you, I said it was more second half weighted. It’s about 30% this half, 70% the next half. Now, what justifies that is in the second half of the year, roughly 10 Sundays we will be completely closed in our Homeplus stores and we’ll have 13 weeks of 24-hour trading closing. So the step up with more Sundays closed is roughly about 5.7% negative like-for-like and about 1.5% negative like-for-like again from the 24-hour impact. So, of course, flowing that forward through to next year, you get the 70 million impact that we’re absorbing in the second half of this year lapping a 30 million impact from the first half of this year next year. So there will be some more impacts for the first half of 2014 and then we should start to lap it. Well, that’s what we know now and it’s lesser than you would think it would be given its legislation and regulation, and that’s because the industry is challenging the regulator that it’s not achieving what they thought it was going to achieve. So things could change, but we thought particularly in terms to consensus where the Asia consensus to us looks too high and that’s the core reason, and that the Korean business is going to – its profits are going to be down about GBP100 million year-on-year.

Price and Value in the U.K.

Caroline Gulliver – Espirito Santo: Caroline Gulliver from Espirito Santo. A couple of questions. The first one is actually just to follow up on the price and value in the U.K. You’ve already touched on this, but just to clarify, are you saying that you’re happy that your competitors are at least advertising that they can price match or better Tesco? I think it even goes as far as now as Ocado saying that they will now price match Tesco including permissions? So are you comfortable with that and do you feel you’re doing enough on the other aspects of price and value? Then the second question is just on China. Is there more that you can do on scaling back the regional costs and head-off the central costs?

Philip Clarke – Group Chief Executive: Am I happy? Well, they like to compare themselves and that’s their business. For us, what’s more important is what we do in our stores, in our communication, and I think we’ve got very good plans. I have to ask myself why do they keep comparing ourselves to us, particularly those who claim to be so much cheaper as some do. While we were playing a song, we’re playing Ken Dodd-Happiness at meeting recently. So maybe that’s quite appropriate. In China, no, I don’t think we can cut back more because it’s three regions. We’ve already taken a big cut. It’s now proportionate for the size of the business. What that business now needs to do is benefit from its renewed focus. I’m not opening so many. I’m loving the stores that it has, and getting some performance out of them. As we watch what happens in the market because as I have said, so many people are finding it tougher.

Philip: A couple of questions. A casual observer of the results like myself might note that you are not doing very well in quite a lot of countries. Should you not be closing or seeking to close down or seeking solutions to more of these countries, because we’ve heard for very long time about how return is going to rise, you’ve got these mature countries who are at the top and the immature at the bottom, something? Should you not be acting a bit quicker? We talked about the U.S., but there are a few others as well. Secondly, you are investing in online nonfood in the U.K. in a big way, increased number of lines. Can you just remind us what the losses were in the first half at Tesco Direct and when do you expect to make some money out of all these investments?

Philip Clarke – Group Chief Executive: I’ll take the first, Laurie can take the second, how’s that? I don’t think we need to make any radical actions in any of these countries. Whoever would’ve imagined that the world would be in the state that it’s in with economies starting to contract, consumer starting to be squeezed. We’ve got a network of stores; we should make the best of them. We can see prospects for convenience to driving those markets. So, no, plans to close down any more countries. We think that the strategy that we have is right. We are going to have to (check) it out as many people are finding it necessary these days. Online nonfood is big investment, and losses and so on Laurie.

Laurie McIlwee – CFO: So year-on-year, losses were about the same, (Philip). So we haven’t improved our overall losses. We haven’t declared or disclosed it separately. The mix is improving, so we will have moving out of categories that have been dragging down the profitability, particularly electrical which we were selling at pretty much zero margin. I’m building a range. You know that we’ve moved the range from 35,000 SKUs at the end of the year, we’re now nearly up to 200,000 and as Philip said in his presentation, there’s a lot of marketplace suppliers that you don’t have the risk of the stock and you do have the income that you get from the products that they sell. We haven’t really kicked in the step change benefits that we talked about of utilizing Tesco’s distribution system, which we feel is a big cost competitive advantage that we’ve got for the future. That’s going to come in the future as we get really through most of the second half of the year. It’s quite a big change. We want to make sure it’s similar that we did for the bank, make sure that we do it carefully and not end up disappointing customers.

Philip Clarke – Group Chief Executive: Yeah, we launched today our domestic electrical venture brand, THX, which is all about haircut. That’s exactly where we should be planning in this space. We’ve been selling other people’s brands at low margins and a year ago I said, you got to do more of selling your brands because using your global supply chain, you can have it manufactured, designed well, manufactured in the factory, brought over to the U.K., sold across – the whole of the group said THS is a good example of that. You see more of that and that’s going to give us a more profitable online general merchandise and in-store general merchandise range and I think the sellers are another important ingredient to the mix. So we move along the road.

Philip: Just to follow-up. So that means about two or three years more of losses do you think in non-food?

Laurie McIlwee – CFO: We haven’t given a number on to it.

Philip Clarke – Group Chief Executive: What it really means is reducing losses, not increasing losses. That’s what we’re aiming to do and eventually that will turn into profits. But you know it is a clearer strategy of us to be a multi-channel retailer in the U.K. Of, they say of share of foods about 30% of share of general merchandises down are 4%, that’s the opportunity, but we’ve got to do is not do (indiscernible) big stores when everyone’s buying on loan.

Dave McCarthy – Investec: Dave McCarthy, Investec. Two or three things. First of all, you’re talking about reallocating space. You know that one of my big piece is the amount of footage that’s going down. So, although, you’re cutting back on your opening program, a lot of that is in the non-food and actually you’re reallocating space within your stores booked to 20%. So can you give us what the increase in the food space that you’re going to be doing both this year and indeed next including that allocation? Secondly, on the margin, you said a flattish margin into the second half caused – usually we see a higher margin in the second half than the first half. So can we take a message on what the U.K. margin is going to do in the first half next year? Is that going to rebase further or are you guiding us to a flat margin first and second half going forward? So just on the balance of the business. Then, thirdly, just a question on what you just said there Philip about the U.S., where you said you’re not going to exit countries and I think the debate about when you ask breaks even is completely irrelevant. The real question is when is it going to stop destroying shareholder value, when is it going to be meaningful, I mean it’s a business in turnover terms about 10th of the size of what you do in London, you’ve got a very heavy, top heavy management team out there that was designed there to build a much bigger business, you wouldn’t tolerate this kind of performance in any other region, so why haven’t we seen any sort of the management team brought back to help out in the U.K. where they have been missed?

Philip Clarke – Group Chief Executive: Well, the new store space expansion is coming down. Over 2 million square feet going, so many as it was up as big as 2.5 million square feet, it’s going to be 1.4 million, 1.6 million square feet this year. I don’t anticipate it’s going to go up in future years. I anticipate it’s going to do the opposite. I think it’s going to continue to come down. We are investing significantly in our own convenience, which is a lot of food space. In terms of what does that mean for food (purchase), we’ll have to get back to because I really haven’t done the calculation, but it’s reducing in real terms. It’s reducing from where it was in prior years and much more focused now on convenience. Gross margins (1.5 and 2.5)?

Laurie McIlwee – CFO: Yes, we’re basically guiding you towards flat margins. So 5.2% for the balance of this year, 5.2% next year. It maybe better, but that’s the guidance that we think is appropriate to give you.