Jeremy Warner's Outlook: Tesco's £2bn risks provoking backlash as Sir Terry piles on agony for others

<preform>Recovery still delayed at Marks &Amp; Spencer - Making the most from falling ratings at ITV</preform>
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The Independent Online

In the past five years, Tesco has doubled both its sales and profits. Figures announced yesterday confirm that last year pre-tax profits finally broke through the £2bn barrier, a retailing first which seems fully to justify Sir Terry Leahy's position as one of Britain's most accomplished chief executives. More than one pound in every eight now goes through a Tesco till. Hurrah. But enough of the plaudits, the job of a professional cynic like me is to identify the fault lines and to assess for how much longer Tesco can sustain this remarkable performance.

In the past five years, Tesco has doubled both its sales and profits. Figures announced yesterday confirm that last year pre-tax profits finally broke through the £2bn barrier, a retailing first which seems fully to justify Sir Terry Leahy's position as one of Britain's most accomplished chief executives. More than one pound in every eight now goes through a Tesco till. Hurrah. But enough of the plaudits, the job of a professional cynic like me is to identify the fault lines and to assess for how much longer Tesco can sustain this remarkable performance.

Fast back seven years and, hard though it is to believe now, Britain's star retailer was Marks & Spencer. Just as the City is today celebrating Tesco's £2bn, back then it was M&S which had just become the first UK retailer to break through the £1bn mark. There was similar laudatory praise, and acres of column inches were devoted to the secrets of Sir Richard Greenbury's success, which was variously attributed among other things to paternalistic management and a high quality British supply chain. The rest, as they say, is history.

At Tesco today, there are few signs of the complacency, inertia and resistance to change which were to prove the undoing of M&S. To the contrary, Tesco seems to have achieved that same virtuous circle of growth that made Wal-Mart into the undisputed king of global retailers - more sales equals greater buying power, equals higher profits, equals greater price discounts, equals greater sales.

At 9 per cent, last year's like-for-like sales growth was the stuff not so much of the market leader in an apparently mature as mature can be industry as some tearaway hi-tech growth stock. Tesco's success is to some degree down to the weakness of its major rivals. Wm Morrison Supermarkets has been all at sea since its apparently disastrous merger with Safeway. The Wal-Mart-owned Asda seems also to have lost the plot over the last year, which is one of the reasons the company recently changed its managing director.

Sir Terry warns against expecting similar growth for the present year, and with J Sainsbury and others showing signs of finally getting their act together, perhaps he's right. Yet it is in non foods that the real Tesco success story lies at present and here there is no sign of the juggernaut grinding to a halt. Perhaps he's right to be so cautious.

To the contrary, as Tesco expands from goods into services, the potential is almost unlimited. A seemingly relentless programme of bigger store openings, notwithstanding planning constraints, is hardly indicative of management planning for a slowdown.

Overall, non foods were up 17 per cent on a like-for-like basis last year, with clothing showing an astonishing 28 per cent rise. No wonder so many high street retailers are finding the going so tough. It's not so much that consumers have stopped spending; rather it seems to be that they've all gone to Tesco.

Even in financial services and in overseas expansion, two of the great graveyards of ambition for British retailers, Tesco's performance has been one of text book success.

So where does the chief threat to Tesco lie? One answer might be by becoming too much like Wal-Mart. In Britain, it's called getting too big for your boots. In other countries it is sometimes referred to as tall poppy syndrome, but either way it involves eventually getting cut down to size.

As Tesco takes an ever greater proportion of the British purse, the dangers of a regulatory and consumer backlash grow steadily greater. To date, competition regulators have leant over backwards to be nice to Tesco, believing, rightly in some respects, that regulators should not stand in the way of what the consumer wants.

But is Tesco really such a great retailer, or is it just increasingly the only retailer around? Unfortunately for Tesco, perception is reality, and rightly or wrongly, many of the same derogatory things that are said about Wal-Mart are beginning to be said about Tesco too. We are still a long way from any kind of tipping point, but a £2bn profit looks to many like too much, especially when it's at the expense of your local street market or friendly corner shop. Sir Terry needs to tread warily from here on in.

Recovery still delayed at Marks &Amp; Spencer

Philip Green would never in the event have paid £4 a share for Marks & Spencer, but that doesn't stop some in the City from continuing to berate the board for turning him down at that price. The chances of Stuart Rose, the chief executive, achieving it seemed as far away as ever yesterday after another disappointing sales update which shows the group is still struggling in clothing, homeware and foods alike.

There is no detailed breakdown of the figures, but it is clear that in the fourth quarter, M&S continued to haemorrhage market share in the core clothing business, notwithstanding Mr Rose's pledge that M&S will never be price uncompetitive with leading rivals again. Falling prices - M&S has cut prices by more than 5 per cent on average over the last year - are hard enough to cope with, but in combination with falling sales, they become a complete nightmare.

Mr Rose has already cut costs sufficiently to prevent another profits warning, but plainly he's going to have to go deeper in the absence of a marked improvement in high street conditions. He'd be unwise to bet on it. Already Mr Rose is planning to cut capital spending by up to a quarter.

M&S claims that hardly any of its stores are individually unprofitable, but even so the time to grasp the nettle of high street closures may finally have arrived. The private equity solution to M&S's problems would be to shrink the company to fit its new, more straightened circumstances. That may be what Mr Rose must contemplate too.

M&S doesn't pretend to compete with the expansion of the supermarkets into non foods. It considers its own brands a cut above the clothing that's on offer in Tesco and Asda. Yet £5 spent on a pair of jeans in Asda is £5 less for spending on the same product in M&S, and although the two may be miles apart in terms of quality and style, it all has its effect.

Potentially, there is still a good if shrunken future for M&S, yet investors will have to be patient to see it.

Making the most from falling ratings at ITV

The bull case for ITV grows ever stronger, notwithstanding the apparent deterioration in the ratings. Mergers are difficult to execute successfully, as Morrison has demonstrated with Safeway, yet the integration of Carlton and Granada has more than delivered on the promised cost savings, and although rivals point to a creative desert in programming, investors have few complaints with the bottom line.

Even the steady deterioration in ratings is not as bad as it seems. As with the BBC, this is more caused by the switch from analogue to digital, where there are a multitude of channels to chose, than by any underlying dissatisfaction with the core ITV1 franchise. Present experience suggests that peak time ratings should bottom out at about 22 per cent, against 27 per cent at present.

The loss of £12 per viewer in advertising this would imply is almost exactly counterbalanced by the saving ITV achieves on the costs of its analogue spectrum, which will shrink from £200m at present to zero at the time of the analogue switch-off in 2012. On top of this ITV expects to save £250m a year on the costs of its public service broadcasting obligations. Even for cash-flush private equity, ITV's £5.3bn stock market capitalisation represents quite a bite, yet it's a wonder the value isn't better reflected in the share price.

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