The Investment Column: Time to check out of Tesco as competitors crowd the floor

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The Independent Online
LESS THAN two weeks before it launches yet another round of permanent price cuts in its UK stores, Tesco was diverting investors' attention overseas.

Terry Leahy, chief executive, said yesterday the group will have 226 overseas stores by 2001 and is spending pounds 700m this year on the plan. Perhaps the international message and the forthcoming domestic discounting are related.

Retail shares are volatile because of the regular trading statements - usually woeful - and consumer spending fears. Tesco, which has oscillated between 157p and 197p in the past 12 months, is especially jumpy.

The market fears it will suffer from increasing competition, particularly from Wal-Mart/Asda, and that it will be seen as a takeover target for the likes of France's Carrefour.

Mr Leahy, in highlighting the international drive, makes Tesco sound like its highly-rated European peers, which are valued by their stock markets on average 40 per cent more. That's down to the Europeans' international exposure. With global retail consolidation barely started, Tesco needs to establish its international credentials before a continental rival snaps it up at a discount.

However, Tesco's core business remains the cut-throat UK market. Stripping out duty increases, Tesco suffered 1 per cent price deflation in the period, which it offset with rising volumes by 3 per cent.

The group is confident it can hold margins flat, at 5.8 per cent, after the forthcoming price cuts, by lifting volumes further. Tesco has budgeted for the move, diverting marketing funds and lifting higher margin non- food sales. Tesco plans to double its market share, currently 3 per cent in non-food products, which should give scope to cut grocery prices. The difficulty, of course, is that volume growth cannot last forever, and when it stops the impact could be severe.

Meanwhile, the expected near-term news of the Thai and Hungarian operations and the financial services arm moving into profit will be counterbalanced by further overseas start-up costs, which sent European profits into reverse in the half-year.

While the overseas expansion will ultimately deliver double-digit earnings growth, this is some way off, and so presumably must be any upward re- rating.

Analysts expect pre-tax profits of pounds 940m for the full year, and earnings of 9.9p per share. Baring the possibility of a hostile bid, the shares, up 1p at 184.5p yesterday, look vulnerable.