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Tesco back in profit but no cause for celebration

The chain’s chief has coaxed back the profits. But lurking behind them lies £18bn of debt.

It was two years ago that Dave Lewis got his first taste of the hysteria that comes with being chief executive of Tesco.

Sir Richard Broadbent, the supermarket’s chairman during much of the disastrous tenure of Philip Clarke, had resigned. At a lunchtime press conference hours later — the first Lewis had attended since joining from the consumer goods giant Unilever — Broadbent answered a final question and got up to leave. He was not allowed to go quietly. The former banker was chased across the room by a Channel 4 camera crew. “Has capitalism failed, Sir Richard?” the presenter screeched, only to be physically blocked from advancing by a burly PR man.

It was into this chaos that Lewis outlined his plan to revive Tesco’s fortunes. Circumstances could hardly have been tougher. The chain was battling with the worst crisis in its history, spiralling out of control amid a series of profit warnings and an accounting scandal that lingers to this day.

Lewis’s plan was simple. He would invest in stores, slash prices and improve relations with suppliers. Unwanted assets, of which he said there were many, would be sold off. It was a radical overhaul from a man known as Drastic Dave in his restructuring days at Unilever.

Since then, Lewis has kept a spectacularly low profile. “Dull Dave is a better name for him now,” one City analyst said last week. “But that’s good. We’ve had enough drama.”

The low-key approach appears to be working and there are signs of a revival at Britain’s biggest supermarket. Last week, Tesco revealed a 60% jump in first-half operating profits to £596m and a 0.6% rise in underlying sales in UK stores. Crucially, Lewis revealed a target of a 3.5%-4% rise in the underlying profit margin by 2020, from 1.7% currently. The news sent the company’s battered share price up nearly 10% on the day.

Although there was plenty of his customary marketing jargon — “strategic drivers” and “moving to the next phase” — Lewis gave the clearest indication yet that the dark days are over. “Tesco is showing real confidence in its recovery,” he said.

Most analysts agreed and rushed to praise the chief executive. “These results demonstrate a clear continuation of the recovery,” wrote analysts at the investment bank UBS.

Yet a small rise in sales and a return to profit is hardly a revival of the glory days for Tesco. A ballooning pension deficit of nearly £6bn means Tesco’s total indebtedness stands at £18bn.

The credit ratings agency Moody’s provided a reality check late last week. It said improving profitability would do little to alter the supermarket’s rating, already one notch into junk status.

In a stinging assessment, Moody’s said that the pension deficit increased the chances of a downgrade. “Tesco’s current ratings and outlook could be at risk if the company cannot make tangible and timely progress in reducing leverage,” it said.

Analysts at the investment bank Jefferies also warned that Tesco’s recovery was “already priced in” to the shares, suggesting further volatility could lie ahead.

Critical to Tesco’s future will be fighting off Aldi and Lidl. Lewis has reduced prices by an average of 6% in two years, which analysts say has helped lure customers back from the German discounters.

The retailer is in a strong position to reduce prices even further because it can use its scale to secure better deals from suppliers. “Tesco’s strategy of lowering prices to win volume share is bad news for competitors,” said Dave McCarthy, an HSBC analyst.

Progress has clearly been made under Lewis. But Tesco is far from out of the woods.

Source - - 9 October 2016