Britain's Biggest Grocer Takes One on the Chin

Shares in Britain's largest grocery store and largest retailer, Tesco (NASDAQOTH: TSCDY  ) , took a hit on Friday as the company announced a reduced forecast and a cut in its dividend. It's the third time this year that the retailer has had to cut back on its outlook, and the stock has fallen 31% year to date. Competitors have suffered similarly, and the future of British grocers is starting to look dire.

Tesco takes another hit
Tesco cited "challenging trading conditions and ongoing investment in [its] customer" as the major factors that brought the business down. Both are tied to the slow recovery the U.K. has undergone in the wake of the financial crisis. The Bank of England said earlier this week that the country may be set with a new normal for wage growth, well below the level set pre-crisis. 

That's put a pinch on shoppers' purses and forced Tesco into a position where deep discounts are the name of the game. The company was already known for its low prices -- its motto is "Every Little Helps" -- but the depth of the discounting has increased.

In its trading update, Tesco also announced it would be bringing in a new CEO a month ahead of schedule. The company's first external CEO, Dave Lewis, joins Tesco from Unilever and will be replacing Philip Clarke, who was kicked out after the company's July profit warning.

A downward slide
Tesco isn't alone in its fall, as many big British brands have been suffering recently. Competitors J Sainsbury and Wm. Morrisons have also been hit, with shares falling 21% and 32%, respectively, in 2014. All three brands have seen declines in comparable sales over the year, as customers simply hold on to more of each paycheck.

The difficulty for the brands is that they've now entered a spiral that takes profits and margins further down. As customers have less to spend, prices have to fall to entice shoppers in, which means lower price expectations across the board, which means deeper discounts are required.

To counteract some of the sales damage, Tesco has cut back on other investments. That includes slowing down the pace of its store refresh program -- never good for sales -- and decreasing investment in IT infrastructure. It's also what led the company to cut back on its dividend, which has dropped 75% compared to last year. 

The bottom line
Tesco is in a bind. Analysts have suggested that now might be the time that the company cuts back on international positions, which have failed to bring in big gains. The company currently generates about 30% of its revenue outside of the U.K., and falling back into a smaller position could free up all kinds of cash. On the other hand, the retailer's Asian business has had some success, and it could help support the company if it continues failing at home.

In the long run, what Tesco really needs is to break free from the downward spiral it's currently caught up in. The company's new CEO may be full of good ideas, but until he can get shoppers to come in for the brand and not for the savings, Tesco is going to be in the same sad spot. There's likely more bad news coming before things turn a corner.

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Andrew Marder

Andrew Marder worked in retail for years, holding jobs ranging from bookseller to bank strategy analyst. He has worked for the Motley Fool since 2012, and loves coffee.

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8/28/2015 4:00 PM
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