Co-op Group emerges from 'rescue' phase

Britain's newly slimmed-down Co-operative Group has returned to profit as it looks to draw a line under the most turbulent periods in its 170-year history, which nearly saw the collapse of its banking arm.

Following two years of scandal, botched deals and boardroom mud-slinging, the supermarkets-to-funeral group declared the "rescue" phase of its turnround complete.

However, the Co-op said it would not reinstate dividend payments to its 8.4m members across the UK, which chief executive Richard Pennycook pushed back to 2017 at the earliest.

The UK's largest mutual will now begin the painstaking process of rebuilding its largely retail-focused business at a time of cut-throat pricing in the UK supermarket sector.

Convenience retail forms the cornerstone of the Co-op's three-year plan to rebuild itself - alongside its remaining funeral care, insurance and legal services businesses - pitting the group against predatory competitors who do not have to weigh commercial success against the social and ethical purpose demanded by its members.

It scored a coup in February by recruiting Allan Leighton, the retail turnround specialist and son of a Co-op store manager who famously transformed Asda in the 1990s, but faces stiff competition from big supermarkets and discounters who are growing their market share at a time when the Co-op's is shrinking.

"This business was a busted flush and could have come down all around us. The fact that it hasn't is great testament to the work that has been done," Mr Leighton said.

The Co-op has been selling assets including its pharmacies and the bulk of its banking operations, to fill a £1.5bn capital hole discovered in its banking arm in 2013 under the reign of "crystal methodist" minister Paul Flowers, who resigned after he was filmed taking drugs.

Without the impact of these one-off disposals, the group "would at best have been break-even", admitted Mr Pennycook on Thursday.

Reporting profit before member payments of £216m in 2014 against losses of £2.3bn a year previously, this has reduced the group's debts by 43 per cent to £808m.

Mr Leighton - who has decided to donate his annual salary to the group's community charities - said the challenge ahead would be to focus on the group's customers and members, who are set to vote on the resolutions at its annual general meeting in May.

Whether the two men have done enough to regain trust remains to be seen. "We have to be a little bit humble," Mr Pennycook said. "We have 150 years of heritage, and for most of those years, we've been doing the right thing. Forgiveness is available, but we can't afford to stumble again."

When it comes to picking their fights, Tesco and J Sainsbury would almost certainly prefer to face a Co-operative supermarket over aggressive discounters like Aldi or Lidl.

The Co-op lacks the scale to lead on price cuts and usually comes off worse in head-to-head high street battles, according to Clive Black, analyst at Shore Capital.

"There is no doubt that where there is a Co-op, Tesco and Sainsbury will look at that and think, we can have a win there," Mr Black said, adding that the groups primary selling point, its ethics, had been undercut by the scandals of the past two years.

The group does, however, have strengths in the convenience market, where it has 2,079 stores, making it the number two supermarket group behind Tesco if larger stores are included.

Although revenues from its food business fell 2 per cent to £7.09bn in 2014, its convenience business held its own, with like-for-like sales growing 3.2 per cent.

Over the next year it plans to grow its convenience market share by opening a further 100 small stores, while offloading between 50 and 75 of its 717 larger-format supermarkets "if the market is right".

With the big four supermarkets cutting costs, closing stores and slowing the expansion of their estates, Co-op chairman Allan Leighton sees an opportunity for the group to advance in the convenience sector.

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But the latest industry data from Kantar Worldpanel, the market research company, suggests that Co-op faces a tough battle ahead. The retailer posted the worst sales performance of the top 10 grocers for the 12 weeks to March 29.

The 1.7 per cent sales drop to £1.5bn is partly due to store closures, according to Chris Longbottom, a director at Kantar, but signs of a turnround at Tesco and Sainsbury's should be a concern to Co-op, he added.

"With Tesco and Sainsbury performing a little bit better, there's a bit of extra pressure on Co-op, in addition to the discounters," Mr Longbottom said.

Mr Longbottom expects Co-op to fall behind fast-growing Aldi to sixth place in the UK supermarket sector in the second half of 2015.

Mr Pennycook said he was "sanguine" about the prospect and focused on promoting Co-op's ethical-product ranges and its convenience business.

But while the supermarkets' drive into convenience retailing has been driven by the "price premium" they are able to charge in local stores, plus the higher sales densities they can achieve, the "pile it high, sell it dearer" philosophy is at odds with the Co-op's ethical stance towards local communities and food producers.

"We have to stay true to the members' values and ethics around what we do," he added, noting the Co-op would only sell free-range eggs, and was proportionally the biggest seller of Fair Trade produce in the UK.

He points to Co-op's Malbec red wine an example of how telling "stories" about products can be a point of differentiation for the supermarket.

"Not only is it a decent drink, but [customers] are contributing directly to schools being set up in the poorest parts of Argentina," he said.

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