LONDON (Reuters Breakingviews) - Tesco’s customer-first strategy will chafe investors. Britain’s biggest grocer by market share reported its first full year of like-for-like sales growth in its core market in seven years on Wednesday. Boss Dave Lewis hopes to shield shoppers from rising prices and avoid crushing suppliers. The risk is that he has to fund that plan with the spoils of Tesco’s 3.7 billion pound ($4.6 billion) purchase of wholesaler Booker.
There is a lot to like in Tesco’s recent performance. A group operating margin of 2.3 percent gets the supermarket closer to its ambitious target of 3.5 percent to 4 percent in three years’ time. Operating profit in the UK and Ireland ticked up 60 percent to 803 million pounds in the 52 weeks to Feb. 25 compared with a year earlier.
The problem is how little is trickling down to shareholders. Customers are doing fine – a typical basket of goods is still 6 percent cheaper than in late 2014. That’s despite food prices turning inflationary since February following almost three years of deflation, according to the Office for National Statistics. Suppliers may be taking some pain but Lewis can at least placate them with promises to shift higher volumes.
Prioritising market share in this way costs money. While Tesco won’t say how much, a slug of the 455 million pounds of costs taken out of the business in the last financial year were used to keep a lid on prices. That narrows the price gap between Tesco and its German nemeses Aldi and Lidl, but hits margins. When Tesco’s international business is stripped out, a UK operating margin of 1.8 percent lags what both J Sainsbury and WM Morrison manage. The risk is that as inflationary pressures ramp up further, some of the synergies of the Booker deal, conservatively estimated at 200 million pounds annually three years into the combination, wind up in shoppers’ pockets rather than shareholders.
Tesco’s recent pledge to resume a dividend payment can’t come soon enough. Since Lewis took over in late 2014, but after the adverse market reaction to its accounting scandal, Tesco shareholders have received a 2 percent annual return while Morrisons returned 20 percent. Prioritising volumes over earnings is a valid strategy, but just like fickle grocery shoppers, investors have choices elsewhere.