Recession's Impact on Fresh & Easy Drags Down Tesco Results

Last Updated Apr 21, 2009 11:12 AM EDT

Tesco has decided to hold back on its expansion into Northern California as losses in the United States operation widened due to economic distress in the West and its inability to add stores as rapidly as planned to help pay for a distribution center and logistical system designed to support many more stores than the company has in operation. Although it originally intended to open about 90 of its Fresh & Easy stores in the U.S. this year, Tesco scaled back plans, putting development of properties it has leased or purchased in and around San Francisco on hold temporarily. They still could open this year if market conditions improve but that's uncertain. Fresh & Easy spokesman Brendan Wonnacott said that, right now, the chain has no store openings planned north of Bakersfield, Calif. It will continue to open stores in its existing markets of Southern California, Las Vegas and Arizona, with its 119th debuting tomorrow in Corona, Calif. Wonnacott would not say how many stores Fresh & Easy continues to have on opening track for this year, but he did mention that the chain plans to hire about 1,500 more workers. With Fresh & Easy locations employing about 25 workers each, that translates into about 60 new stores. Yet, Tesco still needs to operate 400 to 500 of its U.S. Fresh & Easy stores before it can generate sales needed to stem losses associated with its Riverside, Calif., based distribution system. In the fiscal year ended Feb. 28, Tesco lost 142 million pounds, or about $208 million, in the U.S. and 123 million pounds after accounting for exchange rates, or about $180 million. It had predicted a U.S. loss of about 100 million pounds, about $146 million, last year.

In a statement, the company summed up its U.S. woes:

Sales overall were lower than anticipated at the time of last year's preliminary results, as a consequence of our previously announced decision to maintain, rather than accelerate our rate of new store expansion during the second half given the severity of the economic downturn in some geographic markets in the Western U.S.

U.S. trading losses reflect the fact that the U.S. business â€" which has now been trading for 16 months â€" has been built with the necessary infrastructure in place from the beginning to support hundreds of stores. At this stage, it is therefore operating with high overhead and other costs in relation to the scale of the business, whilst also trading from immature stores.

Discounting also hurt profitability. Fresh & Easy stores had to introduced 98 Cent Value Packs in their produce departments some months ago to entice consumers then expanded the program when it proved popular. Just last week, Fresh & Easy launched an initiative that provides discounts for multi-pack purchases, so that 20-count Fresh & Easy tea bags are now available at a bargain price when consumers purchase two at a time.

Simultaneously, competition is heating up. Trader Joe's has been focusing new store growth in California while Wal-Mart and Safeway launched small store formats in Arizona and California respectively to challenge Fresh & Easy for the convenience grocery niche it covets.

Tesco's total U.S. sales were 208 million pounds, about $304 million, last year and same store sales enjoyed a strong advance at 30 percent, which reflect a growing familiarity with Fresh & Easy stores among consumers. Yet, despite that positive sign, the U.S. operation is dragging down Tesco's international business, which contributed 51 percent of the growth in company sales and 45 percent of the growth in profit, if you exclude U.S. results.

Investors may insist that Tesco, which spent about 300 million pounds, about $438 million, on capital expenditures in the U.S. last year as it was suffering 148 million pounds in real losses, apply its resources where it can expect better returns.