Tesco Seeks to Reset Relationship With Suppliers Amid Profit Hit

By Paul Jarvis and Tom Beardsworth

It was Tesco Plc’s (TSCO) relationship with suppliers that led to a black hole in its accounts. Today, the U.K.’s biggest grocer said it will change the way it works with those suppliers by reducing the incentives it receives to sell their products, to put itself on the road to recovery.
That shift won’t come cheap. Tesco today issued an annual profit forecast that trails analysts’ estimates by about 500 million pounds ($782 million). Dave Lewis, the chief executive officer brought in to stop the rot at one of Britain’s best-known companies, said a “material” amount of that shortfall will come from revising arrangements with suppliers.
Tesco has been reeling since September, when the grocer said it had overstated commercial income related to supplier agreements, a practice that has led to executive suspensions and an investigation by the Serious Fraud Office. The company is also fighting a steady march by shoppers to discount competitors, leading to the worst sales decline in more than two decades.
The company is now seeking to reduce rebates, as incentives to
promote suppliers’ goods are known in industry parlance. In return, it will have more flexibility in choosing what products it sells, analysts including Barclays’ James Anstead said, avoid devoting large amounts of shelf space to many varieties of the same item and therefore, being more nimble in meeting customer demands.

Photographer: Simon Dawson/Bloomberg

A Tesco employee scans a customer's purchases at a check out desk inside a Tesco Extra... Read More

“In the longer term, this might lead to a healthier relationship and a sharper commercial position, but it could clearly lead to a short-term profit impact,” Anstead said in a note. He expects Tesco to attempt to recoup “much, if not all, of the foregone income via lower base prices.”
Full-year trading profit won’t exceed 1.4 billion pounds, the Cheshunt, England-based retailer said today, dropping earnings to a level not seen in at least a decade. The shares fell as much as 17 percent to the lowest in almost 15 years and traded 9.7 percent lower as of 1:42 p.m. in London.

‘Restoring Competitiveness’

The forecast provides the first indication of how moves to revive sales will affect earnings following one of the toughest years in Tesco’s history. Lewis will also seek to end practices aimed at “artificially” boosting profit figures toward the end of a financial period, he said. Tesco has in the past reduced staff and stock at the end of the year, Sanford C. Bernstein analyst Bruno Monteyne wrote in a note today.
The reduced guidance is a reflection of “new management getting its house in order,” rather than any worsening in sales, said John Kershaw, an analyst at Exane BNP Paribas.
Tesco’s Lewis said on a call with analysts that there’s been no deterioration in trading during the third quarter of the grocer’s financial year. The period has been “in line, if anything ever so slightly better” than the first half, he said.
Today’s change is a step on ensuring more improvements in the future. Lewis needs to “reconnect with suppliers by changing payment terms and lowering his cost of goods and then start on the long road to rebuilding the Tesco brand with shoppers,” said Mike Dennis, an analyst at Cantor Fitzgerald.