Tesco takes first steps on long road to recovery

Tesco's fall into a £6.4bn loss Convincing investors that Tesco wais on the mend the day it unveiled its biggest corporate loss was never going to be easy.

But that is what Dave Lewis, chief executive, set out to do as he highlighted improving sales despite unveiling a worse than expected £6.4bn pre-tax loss.

Mr Lewis claimed Tesco was not only over the worst of the crisis triggered by a £250m profit overstatement last September but said there were tentative signs of recovery.

"This patient is OK," he insisted, even as he ran through £7bn of charges and writedowns.

These included £4.7bn of property writedowns, most related to its UK store base, as well as £878m of charges on the value of its subsidiaries, £570m for writing off old stock, and £200m for overstating the income it received from suppliers in past years.

Mr Lewis, who was brought in to turn round the retailer in July after his predecessor was ousted, rejected any suggestions that he was kitchen sinking the business. Analysts, however, pointed out that by taking an axe to the value of assets, profits would benefit from lower depreciation in future years.

Most importantly, the chief executive said, Tesco was seeing some signs of improvement.

For the first time in more than four years, both transactions in stores, and the volume of goods sold were growing. "They are pretty good vital signs," he said.

What is more, there had been an improvement in Tesco's biggest stores, "proving that they are not the dinosaurs people have painted them to be".

But while Tesco - which for decades was fighting fit, dominating the grocery sector and venturing into other businesses - may be out of intensive care, analysts said it was far from recovery. Its share price fell more than 5 per cent on Wednesday.

While its trading profit more than halved, from £3.3bn to £1.4bn, in the year to February,Mr Lewis said there was no guarantee that it would even reach that level in the current year.

He said it was Tesco's "aspiration" to reach trading profit - which excludes goodwill amortisation, exceptional items and property profits - of £1.4bn but this was "not a walk in the park".

Tesco faces the challenge of the UK business, which traditionally accounted for the biggest share of sales and profit, sliding to a loss of £30m-£40m in the second half of the financial year.

Conditions remain competitive in the UK, with Aldi and Lidl, the German discounters, opening large numbers of stores.

Meanwhile, Tesco could lose £60m of profits in Hungary, which will push its operations in the country into loss, because of regulatory changes.

Perhaps the biggest danger of relapse lies in the balance sheet.

Tesco made an underlying trading profit of just under £1bn in the year, compared with debt, or debt equivalents of £22bn. One experienced retail banker said this level of leverage, together with Tesco's commitment to put £270m into the pension fund each year was simply unsustainable.

He said Tesco must embark on a rights issue, or find an even more radical solution -- trying to engineer a deal with a big US rival, such as Kroger, whose market capitalisation is about $37bn, for example.

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"Never say never. We keep all options on the table but we have been pretty clear what the pecking order would be," he said.

Tesco is already selling a stake in Dunnhumby, the data analysis business that operates Clubcard. Bankers believe Korea could be a candidate for disposal, or central Europe. The European business, which Mr Lewis has been distinctly lukewarm on, is being consolidated from four operating businesses into one, which could be a prelude to a sale.

Some analysts were also nervous that there could be still more writedowns to come.

Mike Dennis, analyst at Cantor Fitzgerald, said Tesco still needed to close another 200 large stores.

Mr Lewis said there were no plans to do this. The 43 stores closed in the past four months were beyond help. Other struggling stores, Tesco will seek to improve.

The chief executive believed Tesco had done enough to draw a line under the past and reinvigorate the business.

He said if Tesco delivered better than expected profits across the group, he would reinvest them back into the business to win back customers and keep the momentum going.

But Mr Lewis acknowledged that to promise Tesco would encounter no more issues would be a "hostage to fortune".

Indeed, while he was keen to stress Tesco's rehabilitation, he said: "Can it be healthier? Yes it can. Our job is to allow it to be healthier".

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