Investors are Still Waiting for a Turnaround at Tesco

U.K. grocer Tesco has implemented strategies to turn around its business. Yet while results lag, the company's share price has taken a hit and its future growth is in question.

Apr 29, 2014 at 2:17PM

U.K. grocers are navigating rough waters as a combination of depressed U.K. market conditions and competition from discounters is having a negative impact on their earnings. Meanwhile, the market is growing impatient waiting for strategies put in place to deliver improvements in profits.

Tesco (NASDAQOTH:TSCDY) disclosed better-than-expected profits on Wednesday, April 16, and the company's stock price closed for the day up slightly more than 1%. However, Thursday saw the supermarket chain give back more than 50% of its gains, as the certainty of the company's turnaround is being questioned. Shares sank on April 17 by 1.4%, and analysts are seeing a long road for the company to return to form. The company's European and Asian businesses are faring well, but its U.K. home base is showing weakness that could continue into next year.

The company invested about $336 million in upgrades for its stores and to regain customer loyalty. Some analysts believe that discounters are driving away customer traffic and high levels of promotions are the main sales drivers. And Tesco is not the only food retailer whose stock price slipped on Thursday -- J Sainsbury (NASDAQOTH:JSAIY) shares fell 2.1% and Wm. Morrison Supermarkets (NASDAQOTH:MRWSF) dropped 0.3%.

Investing abroad in high-growth markets
Tesco's Chief Executive Officer Philip Clarke is turning the company's investment focus away from Europe and toward high-returning countries like Korea, Malaysia, and Thailand. The company completed its divestment from the U.S. and initiated partnerships with conglomerates CRE in China and Tata Group in India, providing continued access to two of the world's most dynamic markets and setting the stage for further future investment.

For the 52-week period ended Feb. 22, group sales for Tesco rose 0.3%; however, group trading profits decreased across the board in the U.K., Asia, and especially in Europe, where growth slowed by almost 28%.

While the company admitted to experiencing challenges in the U.K., its U.K. online grocery business grew by 11% during the year. Tesco also continues to work on providing customers with multiple channels; during the year, it extended its online grocery shopping service in five countries .

Challenges at other U.K. grocers
Like Tesco, J. Sainsbury has also had to deal with declining sales during its fourth quarter. Part of the reason for the decline has been falling food prices and bad weather, yet the company has been able to maintain its market share of 17%. Sales in the fourth quarter ended March 15 were down 1.5%.

Sainsbury has a more diverse business than Tesco, which has helped its operations. While its food business is facing challenges, its general merchandise and clothing businesses are performing well, especially men's clothing, which grew 23% during the quarter. Its convenience stores also showed strong growth of 15%, though online grocery sales grew at only 6% as the company works on its website launch. A slowdown in the British economy has played a major role in the company's latest results. Economic indicators hint at signs that market improvements are forthcoming, but increases in consumer demand should be delayed.

Wm. Morrison reported underlying earnings per share for fiscal 2013/2014 that decreased 8%. Market challenges and constrained consumer spending have suppressed growth from the beginning of the year's 4% to 2.9% by the fourth quarter. Discounters, who are taking market share, are also challenging Morrisons and its rivals. Morrisons and many of its competitors have resorted to couponing and other promotions to attract customers. Grocery market sales growth, since mid-September, has been flat but has shown upward momentum since early December.

For Morrisons, much like the rest of its competitors, the online channel has delivered strong results, which is part of the reason why Morrisons is expected to grow 125% by 2018. The company's future strategy includes improvements in efficiency through upgrades to its supply chain and manufacturing systems. Changes have also been made to its private-label products, and the square footage of its retail space has increased. As the online food business expands, it is expected to reach 50% of U.K. households by year-end 2014.

My Foolish conclusion
While the U.K. economy remains weak, I would recommend avoiding these stocks until the economy shows signs that consumer demand is starting to pick up again. The continued impact of discounters could also keep future growth low. As Tesco executes its plan of improving its stores while lowering prices on certain items, earnings have yet to show any substantial improvements. As the market anticipates improved earnings, there are many questions swirling around whether or not the current strategy will work. Investors should also be watchful for possible management changes that could be made to restore Tesco's brand.

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