The retailer is grappling with two accounting probes. The latest, by the Financial Reporting Council, was announced last month. The Serious Fraud Office launched a separate investigation in October. Both followed Tesco’s admission it had overstated profits for the first half of its financial year by £263M.
In between these events, on December 9, Tesco unveiled a profit warning, claiming full-year results would be significantly below expectations. The company is expected to announce its radical turnaround agenda in an interim management statement this Thursday (January 8).
Supplier relationships
“We wonder to what extent the accounting issue at Tesco in 2014 and the subsequent changes in supplier relationships will reverberate around the industry,” said Black, director and head of research at Shore Capital.
“Tesco has taken tough decisions that represent clear simplification of supply chain relationships, for which we expect more to come in deconstructing a horrendously complex in-house construct.
“Whilst taking pain now, benefits should ensue down the line, especially if volumes improve, making for larger and more transparent cash flows. We foresee potential benefits to the supply chain emerging from Tesco’s actions and we are interested to see whether or not the market leader’s moves have a broader reach.”
Eight questions
Black outlined eight questions for Tesco ahead of its January 8 announcement.
1: Rights issue – does it need one to strengthen its balance sheet?
2: Disposals – are they necessary for its continued financial health?
3: Pensions – what does it need to do to have firm control of its pension responsibilities?
4: Dividends – what sort of returns should it guarantee shareholders in view of its woes?
5: Cap ex – should it cut capital expenditure further? “Current guidance has been for c£2.1bn annual capital expenditure,” said Black. “We see scope for over £500M to be cut from this per annum, with a focus on sweating a massive existing asset base.”
6: Trading strategy – what is ceo Dave Lewis’s plan to boost sales and cash flow?
7: Store standards – how will improvement in these feature in Lewis’s plans? Black said recent Shore Capital store visits had shown a marked increase in such standards.
8: Wider impact – how will Tesco’s strategy affect the industry?
Addressing all of the top grocery retailers, he anticipated more asset write-downs, although he said if superstore profits improved this might not be necessary.
Underperforming stores
The big supermarkets might also make money by selling off the land underperforming stores were built on, he said.
“We expect 2015 to be a year when the re-engineering of superstores and hypermarkets goes through another gear, embracing down-sizing, new tenants and dark stores for online activities,” he added.
He thought further supermarket consolidation was unlikely, despite the top four’s struggles.
Food price deflation
Amid food price deflation, negative volumes, falling prices, gross margin pressure and collapsing profits among all the top supermarkets, Black expected a mixed Christmas performance from the leading grocery chains.
Overall, 2015 could well be more positive for traditional UK grocery retailers, argued Black, especially because of the sector’s expected return to volume growth.
“Indeed, the fall in grocery prices, motor fuel costs and, soon perhaps, home heating costs, could be one of the most positive drivers of volumes for some time for the whole trade,” he said.