Tesco: buying time

Write-offs, in the words of the economist Andrew Smithers, are either an admission that profits have been overstated or a promise that they will be. Dave Lewis, Tesco's latest chief executive, already disclosed a £263m profit overstatement last year, but the £7bn of one-off charges announced by the UK grocery chain on Wednesday are on a much grander scale.

While the charges are much bigger than expected, the actual cash cost will be only £600m. That means most of the one-offs are changes to balance sheet values, suggesting that the books had been marked with wild optimism originally. Is Tesco's management clearing the way for more optimism in the future by changing the bases for comparison, or salting away reserves to be looted later?

Return on capital will undoubtedly improve. Sending £7bn up in smoke will reduce Tesco's total assets by 10 per cent, shrinking the denominator of that ratio meaningfully.

The headline £7bn figure consists of six main charges. Existing stores are worth £4bn less because trade is weak. A property write-off was expected after UK rival Wm Morrison wrote off £1.3bn of it. Tesco's decision not to complete development of 49 new stores erased another £1bn. Its Chinese joint venture is worth £630m less because that unit's turnround is taking longer than expected. Inventory is worth £570m less because of an accounting policy change, restructuring will cost £416m, and then last year's profit overstatement must be reversed.

Only the property writedowns could improve future profitability, by lowering depreciation charges. Spreading that £4bn over 40 years (Tesco's standard property depreciation period) implies that the boost to margins could be as much as £100m a year. To put that in context, trading profit last year was $1.4bn. Depreciation is a non-cash expense, but the change could make margins look significantly better all the same.

The share price fell 5 per cent on Wednesday. Other than the writedowns the results were in line with expectations. One might have hoped the massive writedowns signalled that management can now see the bottom. Alas, Mr Lewis also warned of increased volatility in the near term. Even with a bit of a push, profits will be under pressure as Tesco's team works to deliver their turnround promise.

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