Outlook: Why the Tesco juggernaut looks unstoppable

Inflationary low; Bird power
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The Independent Online

To judge by the share price reaction - mildly negative - the £1.6bn of profit reported by Tesco yesterday seems to conform to that old stock market joke; the figures were head of expectations but expectations were not exceeded by as much as expected. Sir Terry Leahy, chief executive of Tesco, has reached that enviable position in business where his profits prompt concern from both ends of the spectrum.

In the City, investors and analysts worry that the present pace of profits growth is unsustainable, given the step change in supermarket competition that has been brought about by the merger of Morrison and Safeway. Elsewhere, Tesco is accused of profiteering at its suppliers' and customers' expense.

Neither charge bears any serious analysis.

The excessive profits point first. Business leaders deny it, but in their hearts they all aspire to monopoly. Destroying the competition is, after all, a large part of what business is about. Yet Tesco is coining it not because of its monopolistic instincts, but simply because it is a large, exceptionally well run company. At 10.5 per cent, its return on capital employed is close to what you would expect for an industry with thriving competition. Anything lower, and there's no incentive to invest. Certainly, it's way below that earned by the big high street banks, whose profits look much more vulnerable to regulatory and competitive pressure.

For every pound of sales, Tesco makes just 3.5p of profit after tax, which hardly looks excessive when it is considered that this must fund both dividends and investment. So if the profits are not excessive, what of the worry that they are about to be trounced by a surplus of competition?

On this front too, concern looks overdone. Sir Peter Davis, chief executive of Sainsbury's, recently described the level of price competition among supermarkets as more intense today than at any stage in the last thirty years, yet none of the big supermarket groups has any interest in a price war so vicious and debilitating that they beat each other to a pulp. As the market leader, and in many product categories the price leader, Tesco in any case has a natural advantage over the others in setting the parameters of the price war so as to safeguard its own profitability.

In the short term at least, Tesco probably has more to gain than to lose from the recent merger of Morrison and Safeway. Morrison has introduced some highly aggressive pricing to Safeway, but Sir Terry expects to be a big beneficiary from the inevitable disruption of integrating two very different management and retail formulas. In any case, the strong likelihood of eventually going ex-growth in traditional supermarket groceries has been planned for by aggressive expansion into non foods, convenience stores, and overseas.

So far, there's no sign of any of these strategies going wrong, despite tough trading conditions in Korea, Poland and Slovakia. No business success story can last for ever. Complacency is generally the biggest enemy of business success, and if something else doesn't get there first, it will always destroy a company in the end. Just look what happened to Sainsbury's and Marks & Spencer, where a herculean effort is now required just to stop slipping even further behind. Fortunately for investors, complacency is not a word that can yet be readily associated with Sir Terry Leahy, a restless and driven CEO who fully deserves the gilt edged reputation he's achieved.

So if not complacency, where's the Achilles heal? If there is one at all, it must lie in the company's overseas strategy. Even in today's globalised economy, there's a big political, economic and industrial risk in overseas expansion, if only because the unfamiliar is so much harder to assess and manage. Fortunately, Sir Terry doesn't rest easy in his bed on this front either.

Inflationary low

Inflation was just 1.1 per cent in March under the Government's new fangled measure, the consumer price index, leaving the Governor of the Bank of England, Mervyn King, perilously close to the point at which he has to write an open letter to the Chancellor explaining why the Bank is so far adrift of its inflation target. The Governor is required to write such a letter if the inflation rate is more than one percentage point either side the target rate of 2 per cent. He's also required to say what he's going to do about it.

As things stand, this would be a comparatively easy letter to draft. It would read something like; "If you hadn't changed the wretched target in the first place, I wouldn't have to explain a thing, yours sincerely". Under the old inflation measure of the retail price index, the Bank is still almost spot on target. The difference is accounted for largely by housing and council taxes, which the new measure doesn't take account of.

Be that as it may, it is certainly going to look odd next month if as widely expected the Bank of England opts for another quarter point rise in interest rates. People will reasonably ask; why are interest rates rising when inflation is so low? Many will find the answer - which is that even under the new measure, inflation is expected to rise quite strongly over the next two years - less than convincing.

The problem is more one of perception than reality, but it is also one entirely of the Government's own making. The aim should be to demystify monetary policy. Instead, the Chancellor has added an extra layer of confusion. It is in any case ludicrous to have monetary policy governed by a measure that takes no account of house prices or council taxes, given that these are the two most powerful inflationary forces in the economy right now. Eventually the index will be reformed to include some element of house price inflation, but nobody is too clear when this will happen.

In the meantime the Bank of England is left vainly and unconvincingly protesting that it makes no difference because house price inflation is forecast to abate to zero over the next two years. This seems somewhat unlikely unless the Bank sharply raises interest rates. The quarter point expected to be added to the base rate of 4 per cent next month will make no difference one way or the other.

Interest rates are the wrong tool for cooling the overheated housing market. Too much tightening, and it clobbers the rest of the economy. Yet perhaps regrettably, they are the only thing the Bank of England has to play with. The corset no longer exists, and there are no rules to curb the lending practices of the big mortgage banks. The longer the housing booms goes on, the bigger the demand shock to the rest of the economy when eventually it comes to an end.

The Chancellor counts an independent Bank of England as one of his big successes in macro-economic policy. But is it properly equipped for the latest challenge? I fear not.

Bird power

It was the birds wot won it. Or more particularly, it was the Mediterranean gull, sandwich tern, common tern, little tern and roseate tern, in combination with four migrant species: the dark-bellied Brent goose, the teal, the ringed plover and black-tailed godwit. The Solent and Southampton Water Special Protection Area provides feeding and wintering grounds for more than 50,000 waterfowl and is also designated as an internationally important site for at least five breeding species.

Normally, this would be of interest only to twitchers and wildlife enthusiasts. Yet for the past five years, it has also been an obsession for Bo Lerenius, chief executive of Associated British Ports, who wanted to build a new deep water freight terminal in the area. Even the Royal Society for the Protection of Birds thought the economic arguments would eventually sweep all before them, so it's no wonder the shares reacted as they did to yesterday's news that bird power has won the day. Mr Lerenius has spent £45m on the endeavour. Not even the £100m of capital now freed up to be repaid to shareholders is going to compensate for that.