Tesco Q3 sales towards bottom end of forecasts

A man carries a carrier bag as he leaves a Tesco supermarket in London October 5, 2009.

LONDON (Reuters) - Tesco, the world's No.3 retailer, posted quarterly sales growth towards the bottom end of forecasts, held back by a drop in food price inflation, but said a gradual consumer recovery remained on track.

"We are seeing improving customer confidence and encouraging trends in both the UK and our international businesses, although recessionary conditions still exist in a number of markets," Tesco Chief Executive Terry Leahy said on Tuesday.

The supermarket group, which makes about three quarters of its profit in Britain, said sales at British stores open at least a year rose 2.8 percent, excluding petrol and VAT sales tax, in the 13 weeks to November 28 -- its fiscal third quarter.

That was down from 3.1 percent in the second quarter, below the average forecast of 3 percent in a Reuters poll and despite Tesco doubling customer reward points in August.

"It strikes us that either the initiative isn't working or that the underlying business is continuing to underperform," Morgan Stanley analysts said in a research note.

Data from researchers TNS showed on Tuesday that Tesco held its share of the UK grocery market at 30.6 percent in the 12 weeks to November 28, but lagged the growth of rivals Asda, Sainsbury and Morrison.

Britain is taking longer to emerge from recession than other major economies and a retail survey earlier on Tuesday signalled only a gradual recovery.

The government will also need to raise taxes to tackle its huge deficit and is expected to confirm on Wednesday it is reversing a cut in VAT sales tax which was introduced last year in the depths of the recession.

Tesco Finance Director Laurie McIlwee told Reuters he did not expect the reversal to derail recovery, though he warned against raising the rate above its former 17.5 percent level.

"I don't think that the impact (of VAT rising to its former rate) will reverse the trend in customer confidence," he said in a telephone interview.

"If the VAT goes above that it could be more negative. Just as consumers are getting more confident, to start indirectly taxing people (more) will be a strain on their budgets."

CLOSING THE GAP

Tesco, which has over 4,300 stores in 14 countries, said group sales rose 8.8 percent excluding petrol, with strong growth in Asia offsetting a flat performance in Europe.

That was down from 11.4 percent in the first half but compared well with international rivals like Carrefour SA and Wal-Mart Stores Inc, which are battling food price deflation.

Credit Suisse analyst Andrew Kasoulis said the British figures showed Tesco was closing the gap on faster-growing domestic rivals, having been held back for much of this year by its exposure to discretionary non-food ranges and by the launch of a discount range, which depressed sales growth by value.

Sainsbury reported a 5.4 percent rise in underlying sales for the 16 weeks to October 3 and Morrison a 4.3 percent increase for the 13 weeks to November 1. But these figures did not include as much of the recent fall in food price inflation.

Seymour Pierce analyst Freddie George, however, said the good news was factored into Tesco's shares, which have risen 16 percent in three months, outperforming peers by 17 percent.

JP Morgan analysts also said Tesco's sales performance excluded the impact of IFRIC 13, an accounting rule which changes the timing of revenue recognition of loyalty card incentives and which would depress reported growth rates.

McIlwee said the impact of IFRIC 13 would be "very minor."

At 3:25 p.m. Tesco shares were down 2.3 percent at 425.55 pence, valuing the group at 34 billion pounds. The stock had on Monday hit its highest in over a year.

McIlwee said like-for-like sales of non-food ranges had continued to improve and were now on a par with growth in food.

Sales of the group's premium "Finest" range were also growing again, while its online business delivered a record performance last week, he said.

Food prices were likely to remain flat and Tesco's full-year performance expectations were unchanged, he said.

(Editing by David Holmes)