Tesco: In need of a little help

To turn around the supermarket giant Philip Clarke must address five key problem areas when he presents annual results next week, says James Thompson

When the new group chief executive of Tesco presented its full-year results last April, he promised a new era of more open communication: "I will do it differently," Philip Clarke said.

At the time, he probably didn't envisage that he would have to communicate the grocery giant's first profit warning in 20 years – preceded by a controversial share sale by director Bob Robbins, a deterioration in already dire UK underlying sales, a botched £500m price campaign and the departure of a series of executives.

Skip forward a year, the fact that disgruntled shareholders are now willing to air misgivings about its banking and US operation in public means that Tesco is under the microscope like never before, following an unerring 14 years under the leadership of Sir Terry Leahy, who left in March 2011.

In defence of Mr Clarke, its former international chief, the grocer's UK business has been under pressure from rivals Sainsbury's, Morrisons and Asda for much of the past six years. He will also be able to boast a 2 per cent rise to £3.88bn in underlying profits over the year to February.

But make no mistake, the Tesco boss will have to deliver the performance of his career on Wednesday to convince the City he has a blueprint to turn around its spluttering UK operation, as well as address concerns about other parts of its global empire, from its loss-making US business to the slow progress at its banking operation.

Clive Black, an analyst at Shore Capital, said: "The initial priority has to be to stabilise the core chain in the UK and give investors confidence that the profit warning on 12 January is a single event and not the first of others."

To help turnaround its UK fortunes, Mr Clarke will provide more details about Tesco's huge investment in its UK business, which was the main reason for it warning in January of "minimal group trading profit growth" in 2012-13. JPMorgan Cazenove expects Tesco to splash out £792m over two years on refurbishing its UK store estate, in addition to £245m in improving customer service through hiring 22,921 new full- and part-time staff.

Bryan Roberts, the insights director at Kantar Retail, offers a hard-hitting assessment of what has gone wrong.

He said: "I am in a variety of Tesco stores at least three times a week, largely in the South-east, and they go from very good to just appalling. There is a lot of saving and scrimping going on in stores, compared with some of their competitors. For example, this can range from them not having enough carrier bags to not enough staff in stores."

Dave McCarthy, an analyst at Investec, said there are three key areas that need sharpening up.

"Tesco needs to improve its price positioning and be more aggressive on price. Philip Clarke needs to improve the service levels in stores, which will involve putting more staff back in there. And lastly, he has got to improve the quality of its products, primarily in fresh food. They are all huge, huge tasks."

At a time of a breakneck store opening programme by the big four grocers, Nick Coulter, an analyst at Nomura, expects Mr Clarke to also signal a "phased reduction in its rate of UK space growth with a shift in emphasis away from large hypermarkets towards smaller formats".

Reflecting this, he forecasts that Tesco will cut its UK capital expenditure by £200m to £1.3bn this year.

The City also wants Mr Clarke to hire a new UK chief executive inside the next 12-18 months after the exit of its domestic boss Richard Brasher last month. Following a disagreement over strategy with Mr Brasher, Mr Clarke took control of running the UK operation, which accounts for more than two-thirds of group profits.

Moira Benigson, managing partner at the executive search firm MBS Group, said: "I think that Philip Clarke has plenty of people internally he could put into the role of UK chief executive from across all areas, such as finance and food, if he in fact decides to appoint a new UK CEO."

She added: "While he has already made a start, Philip Clarke needs to mix it up and make more of his own appointments as soon as possible. He needs to put his own stamp on the business and build up a pipeline of talent similar to the way that Justin King did after he took the top job at Sainsbury's."

Beyond these shores, Mr Clarke will also be pressed on Tesco's strategy for the US. Since launching Fresh & Easy there in November 2007, Tesco has racked up losses of £700m and splashed out £1bn of capital across the pond.

While Mr Clarke has set its US business the target of "breaking even" by February 2013, the group's third-biggest shareholder, Legal & General, last week put pressure on it to quit Fresh & Easy.

Mr Black said: "Philip Clarke has got to make sure the losses in America actually come to an end this financial year."

But he warned: "Fresh & Easy has to have the prospect of delivering a positive return on capital and if it does not then it will eventually have to be closed, sold or joint ventured."

Elsewhere, Mr Clarke will also be quizzed on the strategy for its banking division and non-food operation.

In October, Tesco said it had opted to "slow" the final stage migration from the systems it inherited from Royal Bank of Scotland to its own, which has contributed to it delaying the launch of mortgages and current accounts.

Mr Roberts said: "I think banking is a big opportunity. The margins on banking products can be six times greater than standard retailing, so that is a potential cash-cow business of the future for Tesco. Anyone who is calling for them to get rid of banking is taking a very short-term view."

Similarly in non-food, Tesco has lost its way in certain categories recently, with Mr Roberts saying its clothing "still compares poorly to George at Asda".

Arguably, above all, Mr Clarke will need to convince the City that Tesco can be famous again for the slickness of its UK grocery operations.

Mr Roberts said: "Tesco used to be amazing in areas such as loyalty cards, private label and e-commerce, but that is not the case at the moment."

If Mr Clarke is not able to whip Tesco UK into shape, he could find that investors start to lose their patience, as the grocer's shares have tumbled from 403.5p at the start of this year to 322p yesterday.

While Tesco's chief executive will be able on Wednesday to point to strong performances in many of the 14 countries where it operates, from Turkey to Malaysia and South Korea, the problem with its British business is that it can often take a long time for a big grocer to regain momentum.

Mr McCarthy says: "The important thing is that it has taken Tesco a number of years to get into this situation. It has not happened overnight and it will not be fixed overnight."

Five key problem areas

1 Fix the UK business by refurbishing its stores, improving the product offer and sharpening up service with more staff.

2 Hire a new UK chief executive. The City believes that Tesco is too big for Philip Clarke to be both group and UK boss.

3 Get Tesco Bank moving. It is still to launch mortgage and current accounts and is tinkering with the IT.

4 Provide a clear strategy for Tesco to deliver substantial returns on its loss-making US business, Fresh & Easy.

5 Sharpen up its non-food ranges, such as improving the quality and presentation of its clothing in stores.