Woolies warns on profits after Tesco setback

Woolworths was forced to issue a profits warning yesterday despite stronger Christmas sales after Tesco played hardball over the terms of an entertainment supply contract.

The supermarket giant has slashed the amount it is prepared to pay Woolworths' Entertainment UK arm, which supplies Tesco's home entertainment lines, knocking £10m off next year's profits. Shares in Wooliesfell 12 per cent to 32.25p.

Trevor Bish-Jones, the chief executive, said it was unlikely the three-year contract with Tesco would be renewed when it expires in February 2007. "I won't write unattractive business. We put our best price forward and Tesco has not accepted that offer. There is no recourse. That's the way the commercial cut and thrust of life works," he said.

Almost half of EUK's revenues come from supplying Tesco, with the bulk of the rest coming from Woolworths. Contracts with WH Smith, Wm Morrison, Amazon and Play.com comprise just 10 per cent of the unit's sales. Mr Bish-Jones pointed out that EUK had recovered from the blow of losing key contracts in the past, notably its supply deal with Asda in the late 1990s.

The EUK blow overshadowed evidence that trading at Woolworths had picked up over Christmas after a disappointing autumn. This puts the group on course to hit the upper end of the £50m to £60m consensus profits forecasts under UK GAAP, although increased leasing charges under the new IFRS accounting rules will wipe £11m off profits.

Underlying sales over the six weeks to 14 January slid 0.8 per cent, which was better than expected, while gross margins improved by 40 basis points. The sales recovery, which followed months of disappointment, limited the like-for-like fall in sales for the first 50 weeks of its financial year to 3.9 per cent.

Mr Bish-Jones said the group's first internet Christmas had been a success, with online sales accounting for 4 per cent of group revenues in its peak week. The group's system of putting internet terminals in its smaller stores to allow customers to access its website gave the 800 small outlets "elastic walls". Toys, stationery and computer games sold well, with gift sets proving less popular as consumers made "focused" purchases, he added.

Matthew McEachran, at Investec, cut his profits forecasts under IFRS by £12m to £43m for the current year to reflect the additional property costs, and halved next year's estimates to £21m. "Any euphoria about a good delivery of Christmas is shattered by the sting in the tail from EUK and IFRS," he said.

Woolworths' rival Instore issued a profits warning yesterday after disappointing second-half sales.