Mike Dennis Comments: Tesco’s tough love strategy applauded by the City

January 8, 2015, Proactiveinvestors.co.uk

Tesco (LON:TSCO) boss Dave Lewis sprung a surprise by administering a large dose of tough love, as he strives to get the ailing supermarket giant back on its feet.
 

This included scrapping the final dividend, cutting capital investment by £1bn and reducing costs by £250mln by closing 43 unprofitable stores.
 
The City applauded the move by driving the stock to the top of the Footsie leader board. Shares, down 36% over the last year, were up 15% following the results, adding £2.2bn to the market capitalisation of the company.
 
The root of Tesco’s recent problems has been the UK and Lewis has signalled his intent by hiring Halfords boss Matt Davies to run the UK business.
 
This wasn’t the piecemeal stuff of his predecessors, but a good first stab at turning the retail super tanker around, retail analysts said.
 
It followed the year from hell for Tesco, which issued four earnings alerts, sacked its chief executive and suspended eight senior staff members after profits were found to be overstated to the tune of £263mln.
 
"For a man parachuted onto the bridge of a sinking ship, Dave Lewis has set about the task of plugging the leaks with aplomb,” said Phil Dorrell, director of the consultancy Retail Remedy.
 
In a bid to shore up the balance sheet, Lewis also revealed plans to sell Tesco Broadband and the online entertainment service blinkbox to TalkTalk.
 
The marketing services group Dunhumby is also on the auction block.
 
The proceeds of the disposals and the reining back of spending will help partially patch up the threadbare balance sheet that is expected to be further hit by property write-downs.
 
Analysts believe Tesco needs to raise around £3bn if it is to maintain the investment grade on its debt.
 
This is why many followers of the group predicted that a rights issue for that amount would be forthcoming, or further, more significant disposals.
 
And, in fact, Tesco has said this morning it is looking at “further actions to maximise shareholder value”.
 
“We should expect a lot more asset sales if Tesco is planning to write down its property values; maybe this will be announced at the full-year results,” said Mike Dennis, retail analyst at Cantor Fitzgerald.
 
There were some positives in the announcement. Earnings guidance was maintained, while the business had a better Christmas than expected in the UK with sales over the festive period down just 0.3%.
 
For the 19 weeks reviewed the decline was 2.9% – which compared to a 5.4% in the three months prior.
 
Lewis told investors: "We are seeing the benefits of listening to our customers. The investments we are making in service, availability and selectively in price are already resulting in a better shopping experience.
 
“A broad-based improvement has built gradually through the third quarter, leading to a strong Christmas trading performance.”
 
Analysts said the announcement was just the beginning of a strategy to return Tesco’s UK grocery operations back to its competitive best.
 
Cantor Fitzgerald reckons the initiatives outlined by Lewis should boost profit margins by around three and a half percentage points over the next 36 months.
 
However, the broker said Tesco’s price cuts will be a more modest proportion of sales than Asda’s and Sainsbury’s, which were a combined £450mln.
 
Tesco (LON:TSCO) boss Dave Lewis surprised a few people in the City by administering a large dose of tough love, which he will hope gets the ailing supermarket giant back on its feet.
 
This included scrapping the final dividend, cutting capital investment by £1bn and reducing costs by £250mln by closing 43 unprofitable stores.
 
The root of Tesco’s recent problems has been the UK and Lewis has signalled his intent by hiring Halfords boss Matt Davies to run the UK business.
 
This wasn’t the piecemeal stuff of his predecessors, but a good first stab at turning the retail super tanker around, retail analysts said.
 
It followed the year from hell for Tesco, which issued four earnings alerts, sacked its chief executive and suspended eight senior staff members after profits were found to be overstated to the tune of £263mln.
 
Today’s announcement prompted a 10% rise in the share price – which has fallen 40% in the last year.
 
"For a man parachuted onto the bridge of a sinking ship, Dave Lewis has set about the task of plugging the leaks with aplomb,” said Phil Dorrell, director of the consultancy Retail Remedy.
 
In a bid to shore up the balance sheet, Lewis also revealed plans to sell Tesco Broadband and the online entertainment service blinkbox to TalkTalk.
 
The marketing services group Dunhumby is also on the auction block.
 
The proceeds of the disposals and the reining back of spending will help partially patch up the threadbare balance sheet that is expected to be further hit by property write-downs.
 
Analysts believe Tesco needs to raise around £3bn if it is to maintain the investment grade on its debt.
 
This is why many followers of the group predicted that a rights issue for that amount would be forthcoming, or further, more significant disposals.
 
And, in fact, Tesco has said this morning it is looking at “further actions to maximise shareholder value”.
 
“We should expect a lot more asset sales if Tesco is planning to write down its property values; maybe this will be announced at the full-year results,” said Mike Dennis, retail analyst at Cantor Fitzgerald.
 
There were some positives in the announcement. Earnings guidance was maintained, while the business had a better Christmas than expected in the UK with sales over the festive period down just 0.3%.
 
For the 19 weeks reviewed the decline was 2.9% – which compared to a 5.4% in the three months prior.
 
Lewis told investors: "We are seeing the benefits of listening to our customers. The investments we are making in service, availability and selectively in price are already resulting in a better shopping experience.
 
“A broad-based improvement has built gradually through the third quarter, leading to a strong Christmas trading performance.”
 
Analysts said the announcement was just the beginning of a strategy to return Tesco’s UK grocery operations back to its competitive best.
 
Cantor Fitzgerald reckons the initiatives outlined by Lewis should boost profit margins by around three and a half percentage points over the next 36 months.
 
However, the broker said Tesco’s price cuts will be a more modest proportion of sales than Asda’s and Sainsbury’s, which were a combined £450mln.
 
Not all City firms were totally convinced. Wealth management specialist Killik recommended caution.
 
“It is clear that part of the better than expected performance is from strong Black Friday sales, a phenomenon that didn’t exist in the previous year, and which is likely to have sucked in demand from the rest of the year and at lower prices and margins. We would want to see some actual performance improvement in the core grocery business before making any judgement as to the recovery potential in Tesco,” Killik said.