april 22 tg tesco 223p

UK Equity Ideas

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Analyst: Tim Green +44 (0) 20 7878 4185 [email protected] Website: www.mirabaud.com

22 April 2015

One Tesco swallow not enough to make a high-quality summer Tesco’s new chief executive Dave Lewis has worked hard to beat Tesco (223p) into some kind of shape during his first seven months in the job. Given the huge legacy of issues he has had to deal with, as well as his desire to take some radical decisions like shutting down the awful Cheshunt HQ and moving it to Welwyn Garden City, he has made a good fist of it so far. Throwing money and effort into first getting service and availability up to scratch, so that he can get maximum leverage out of price cuts all makes good sense. This has duly led to his first swallow, in the shape of the UK LFL volume growth (1.2%) over the final quarter of last year, the first positive UK volume figure after four years of declines. In tandem with this, UK transactions have also edged into positive territory during the final quarter, for the first time in at least a couple of years. This focus on volume-led recovery fits with the traditional wisdom of saving a supermarket chain, as was ably demonstrated by Justin King when he had to pick up the pieces as the new chief executive of Sainsbury around a decade ago. Prices will be what they will be and the outlook for them is particularly uncertain at a time of commodity deflation and supermarket price wars. Tesco’s UK LFL growth was still 1% negative in the last quarter. So one needs to fix on something more immediately achievable than an absolute sales figure, even if one hopes that the latter will come sooner rather than later. However, there was something lacking in today’s full-year results presentation. Whilst Mr Lewis put a lot of emphasis of the volume-driving powers of better service, availability and price, one word was curiously absent in the presentation: quality. As far as we can see, the word did not appear once in either the results release or presentation slides. Now our comment may be unfair, since plans to continue a full series of range reviews were highlighted; but the emphasis here was on cutting the number of products. We agree with the company that the number of products was excessive and that cuts are right, without losing the numerical, choice advantage that should give added appeal, at least when compared to the much smaller ranges of Aldi and Lidl. But surely quality deserves a mention too? Perhaps, for competitive reasons, Mr Lewis is not giving too much away. The emphasis on “reinvestment, reinvestment, reinvestment” in the customer offer - Mr Lewis’s words - must surely include quality, we assume. Nevertheless we are rather surprised at its apparent omission. By contrast, it was clear that a large part of the reinvestment plan would be lowering prices, as Mr Lewis believes that Tesco’s prices are still too high overall. However, Justin King placed the improvement of product quality at the centre of his successful, sales-led recovery plan. Sainsbury may be different from Tesco but quality matters. Even a look at the accelerating success of Aldi and Lidl shows that higher quality has been a key component of their growth, not just low prices. In their case, there has been a sharply increased emphasis on British sourcing, for example in meat products, which has played a key role in upgrading their own brand offer and its appeal. Cutting prices is one thing and it obviously boosts volumes; but lower prices must also be offset by customers

UK Equity Ideas



trading up, paying higher prices for higher quality, own brand products. This is a must for a broad-range operator like Tesco. One final thing to watch for, briefly alluded to by Mr Lewis in his presentation: lower prices for food, and more recently petrol, have given customers a wodge of extra cash but they have decided to spend it elsewhere, not at Tesco. Namely on holidays, paying down debt or - we would add - on a host of things like cars and Sky TV subscriptions. Indeed, look at how Sky, the young usurper, has reached level pegging with Tesco in terms of market capitalisation – an unthinkable possibility perhaps before Tesco’s travails. Therefore, Tesco has an urgent need to become much more relevant again to the consumer. Although Tesco Bank is a complementary part of that effort and a more focused effort on food will help, there is still much to prove. That doubt may also need to be more fully discounted in the share price. There are compounding doubts to deal with, such as sorting out the weakness in Asia and continental Europe and possible extra charges related to the pension scheme. Tesco should be fixable - in the UK at least - and Mr Lewis may be the person to do it. However, we are not yet drawn to consider backing such an assessment at the current share price.

Tesco and Sky’s market cap converge (to around £18.5bn)

Source: FactSet

Tim Green UK Equity Commentator T +44 (0)20 7878 4185 F +44 (0)20 7930 4068 Email: [email protected]

MIRABAUD Securities LLP 33, Grosvenor Place London SW1X 7HY

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T +44 20 7321 2508 F +44 20 7930 4068

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april 22 tg tesco 223p

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