Mike Dennis Comments: Tesco store closures herald broader property overhaul

January 9, 2015, Reuters

* 43 stores set to close, many of them small Express format
 
* 49 development projects for big stores scrapped

* Review of property portfolio worth over 24 bln pounds

* More writedowns expected

* Questions over store revamps after capex slashed

By Emma Thomasson and James Davey

LONDON/BERLIN, Jan 8 (Reuters) – Tesco’s announcement on Thursday that it will close 43 stores and cancel another 49 developments is just the start of a review of a huge property portfolio that is out of tune with modern shopping habits.

The world’s biggest retailers are all struggling to adapt as time-pressed customers buy more groceries locally or online rather than shopping in the out-of-town megastores that flourished in previous decades.

Tesco, which had pursued a strategy of buying up as much British development land as possible, has a property portfolio it valued last year at more than 24 billion pounds ($36 billion), dwarfing its market capitalisation of 15 billion.

"The big issue for Tesco is the reliance on superstores. They have to accept that shopping habits have permanently changed," said Planet Retail analyst Natalie Berg. "We could see more store closures in the future.

New Tesco boss Dave Lewis said the 49 cancelled development projects were mainly for very large stores, adding that development of 23 other sites would still be pursued.

Those scrapped developments would have added almost five percent to Tesco’s existing UK sales space across more than 2,600 stores. More than half of that sales space already comes from larger format stores.

Given market trends and a decision to slash capital expenditure to help fund price cuts, Lewis said building yet more big stores did not make sense and said Tesco needed to think differently about how to use its existing space.

His predecessor Phil Clarke had pursued a strategy of filling unused space with Giraffe restaurants, Euphorium bakeries and Harris + Hoole cafes. Tesco also announced a plan earlier this year to build 4,000 new homes on its unused land and sell other sites to developers.

Lewis said that a review of the property portfolio would be completed by the end of the financial year in February.

PROPERTY WRITEDOWNS?

Real estate experts CBRE said planned UK grocery space has declined by about four percent since a 2012 peak.

Clarke declared in 2013 an end to the "space race" among British grocers, writing down the value of Tesco’s UK property by 804 million pounds and ending development of over 100 sites.

More writedowns could be on the horizon. Cantor Fitzgerald analyst Mike Dennis says Tesco might need to write down 2 billion pounds on UK land and existing supermarkets, potentially triggering a credit ratings downgrade to junk if the Tesco fails to raise enough cash from planned asset sales.

Mark Charlton from real estate firm Colliers said some of the 49 abandoned sites in the south could be sold to residential developers, but it would probably be hard to find buyers for the rest, meaning their value would have to be written down.

In November, rival Sainsbury’s booked exceptional charges of 665 million pounds, mainly impairment charges on existing stores and the property pipeline, saying some 40 stores it had planned to develop will not now be built.

France’s Carrefour, which faces similar challenges to Tesco due to its huge hypermarkets has moved faster to restructure. It increased its capital expenditure in 2014 to around 2.5 billion euros ($3 billion) to renovate and expand stores.

Lewis said more than half of the 43 unprofitable stores set to close were in the small Express format, of which Tesco runs almost 1,700 in Britain.

That suggests that Tesco cannot just compensate for falling megastore sales by rushing to grab smaller sites: "They made some rash decisions which lacked commercial rigour," said Kantar Retail analyst Bryan Roberts.

Tesco said less a third of its slashed 1 billion pound investment budget for 2015/16 would go on maintaining and refreshing its existing stores, suggesting it will further slow a programme to revamp its huge Extra stores.

"The 1 billion pounds planned for next year is well below depreciation and there will perhaps be a concern if that is too aggressive," said Citi analyst Pradeep Pratti. ($1 = 0.6641 pounds) ($1 = 0.8474 euros) (Editing by Keith Weir)