Tesco Seeks to Defend Fresh & Easy Operation

ELLIOT ZWIEBACH

LONDON — The upbeat comments of Tesco management last week about the performance of Fresh & Easy Neighborhood Markets allayed the long-range concerns of some observers on both sides of the Atlantic, though others remained skeptical.

“The howlers at the moon should be silenced,” Philip Dorgan, an analyst with Panmure Gordon & Co. here, told SN.

But Mike J. Dennis, a London-based analyst with Piper Jaffray, Minneapolis, said he is still not convinced. “If this is such a success story, why hide it by not disclosing any actual figures?” he told SN.

The company said it will break out U.S. sales as part of the chain's international segment beginning with the first-half financial report in September.

Tesco officials were not specific about overall sales at the 61 Fresh & Easy stores operating in Southern California, Arizona and Nevada, noting only that they were very encouraged that sales at some of “the best locations” are exceeding $20 per square foot per week — better than the U.S. average, which Tesco estimated at $9 to $10 per square foot.

Speaking to analysts at a meeting here to discuss year-end financial results — and in an interview on Tesco's website — Sir Terry Leahy, chief executive officer, expressed enthusiasm for the company's U.S. experience so far.

“It's exactly 167 days since we opened our first [Fresh & Easy] store, and it's going much better than I could have hoped for, though of course it's still too early to make definitive judgments,” he said. “But the trajectory of sales is good at the 27 stores we opened just before Christmas, where we have a little bit of a base.”

He said fresh foods are selling well, particularly prepared foods and ready meals, and own-brand sales “are also strong, confirming that the core of our offer is in tune with today's American consumers.

“The stores are performing ahead of budget, and more importantly, customers love [them] and we're getting the best feedback we have ever had from any format we've opened anywhere,” Leahy said, citing an independent survey conducted a couple of weeks ago in Las Vegas by Paris-based Ipsos “[that] couldn't find a single dissatisfied customer.”

While not disclosing sales figures, the company indicated Fresh & Easy lost close to $120 million in the four months prior to the Feb. 23 end of Tesco's fiscal year and was likely to lose nearly $200 million more this year.

“The news that Fresh & Easy is achieving sales densities above the U.S. industry average suggests the worst fears expressed in some quarters can be discounted,” said James Anstead, a London-based analyst with Citigroup, New York.

“The steady improvement in Fresh & Easy sales bodes well for the future. However, the forecast of losses of 100 million pounds [just under $200 million] for 2008-2009 is a big step up from our forecast of 40 million pounds [about $80 million], suggesting a lengthy road to profitability.”

Dorgan, head of research for Panmure Gordon & Co., a London-based investment banking firm, said he remains optimistic about Tesco's ultimate success in the U.S. “When you start a business from scratch, as Tesco has done with Fresh & Easy, it involves a difficult budgeting process, and forecasting growth is a tricky thing.

“But it's not in Leahy's nature to over-hype things. He can't guarantee success at this point, and that's perfectly sensible because no one knows for sure what will happen. But clearly he's not disappointed with the level of sales, and he's pleased with what consumers are saying.”

Dorgan also said Tesco “is very happy the industry is underestimating them.”

Other observers, including Dennis, said they would like to see actual sales numbers before they change their opinions.

“Management suggests it's still the early days,” he told SN, “but they disclosed sales figures in Turkey after just six weeks of operation there and in Taiwan after only a month. And why, after such a short period of time, is Tesco sending [Jeff Adams] to be the new No. 2 executive in the U.S. if everything is going so well?”

Mike Griswold, a Boise, Idaho-based consultant with AMR Research Boston, told SN the sketchy numbers still raise some questions. “What they're not telling us is what total sales per square foot are across all stores, and it's my sense that number is not anywhere near $20,” he said.

It's possible Tesco did a better job selecting locations for stores opened this year than it did for stores opened during the last two months of 2007, Griswold said, given the positive feedback from customers in Las Vegas. “Those stores opened later than most of the ones in Southern California and the early Arizona locations, and Tesco may have had more confidence about succeeding at those locations,” he pointed out.

With low traffic reported at some locations “that are not among the company's best, you will probably see Tesco getting out of some of those stores,” he added.

Dennis told SN it would be out of character for Tesco to contemplate closing stores, “because they pride themselves on their very extensive site research, and I'd be surprised if they were to close any Fresh & Easy stores.”

Jim Hertel, managing partner at Willard Bishop, Barrington, Ill., told SN he was surprised “at how bullish Tesco is about the Fresh & Easy concept, and by the fact they still plan to open 150 more stores this year and go ahead with plans for a Northern California distribution center.”

He said he was not surprised with surveys that indicate high levels of customer satisfaction with the stores, “because the more often people shop at Fresh & Easy, the more satisfied they seem to be.”

For the fiscal year that ended Feb. 23, Tesco's net income (trading profits) increased 11% to $5.4 billion (U.S.) and sales rose 11.1% to $101.6 billion. In the chain's United Kingdom segment, which includes Fresh & Easy, net income for the year rose 7.1% to $4 billion and sales were up 6.7% to $74.4 billion, with same-store sales, excluding fuel, up 3.5%.

Andrew T. Higginson, the chain's finance and strategy director, said anticipated losses will climb this year, “as we continue to build our store network and accelerate the opening of our second distribution center, in Northern California.”

The company said it expects losses to begin declining after the current year “as early stores begin to mature and we see increased overhead recovery from higher volumes.”

Capital spending at Fresh & Easy will jump to $725 million from just under $400 million this year, Higginson indicated, “reflecting the decision to bring forward our investments in Northern California.”

Leahy said Fresh & Easy's growth is coming from a combination of existing customers buying more products and new customers. He said approximately 20% of shoppers questioned in the Ipsos survey were in the store for the first time.

“The thing that encourages me is that the appeal is almost uniformly strong across all income groups, which is pretty unique in America. That potent mix of industry-leading prices, plus quality and freshness not seen before, has really cut across all income groups and all age groups. The retired market is a huge one in the U.S., and that has also made a big impact.”

He acknowledged the stores are running a little behind in attracting “the biggest families” — those with six or seven people in a household, who may think Fresh & Easy will not be able to deliver a complete one-stop shopping experience, he pointed out. “But even among some of the very biggest Hispanic families, which would be the hardest ones to [attract], the audited range is good and improving rapidly all the time,” Leahy said.