Germany's Aldi Pressures Tesco, Threatens U.S. Growth

(MoneyWatch)  Tesco's sales grew 12 percent in the third quarter, but deeper in the company's results are signs that it may face problems with its Fresh & Easy operation in the United States.

Tesco's two percent growth in comparable-store sales core U.K. market was better than the disaster many analysts had expected, but that growth came at a cost. Pressure from German discounters Aldi and Lidl is crimping Tesco, which started discounting heavily in September. Aldi is a particular threat, having expanded its U.K. market share for five straight months as part of a prolonged expansion.

Tesco's global profitability problems may have a significant impact on the prospects for the 60 Fresh & Easy stores it operates in the Western U.S. Aldi-owned Trader Joe's, headquartered in California, is Fresh & Easy's keenest rival for the niche in low-cost gourmet food. Because Trader Joe's has built a stellar reputation over 40 years, Aldi is positioned to drive up Fresh & Easy's cost of customer acquisition, depressing Tesco's U.S. profitability at the same time Aldi is squeezing Tesco's U.K. margins. As such, Tesco is going to have to decide whether its priority should be investing in U.S. expansion or lower U.K. prices.

At launch, Tesco committed $400 million to build a California distribution center and the 300 to 400 affiliated stores it needs to operate Fresh & Easy profitably. Yet, Fresh & Easy recently had to spend money brightening up what had been industrially drab stores.

Tesco slowed the pace of Fresh & Easy growth but decided to accelerate development in the densely populated -- and expensive -- San Francisco market after initially focusing on more suburban locations, Fresh & Easy being derived from Tesco's urban oriented Express format.

In the meantime, Trader Joe's continues to add stores, with four of the five outlets "coming soon" taking aim at Fresh & Easy's core California market. Which, of course, just adds to Tesco's woes.