Tesco may be close to exiting its US venture Fresh & Easy, which has absorbed nearly £1B of capital since its 2007 launch and not shown a profit, say sources

Cindy Allen

LONDON , October 26, 2012 (Thomson Reuters) – Tesco's billion pound gamble to crack the United States may have only months to run as investors and management focus more squarely on the British retailer's struggling home business and slowing growth in emerging markets. Fresh & Easy (F&E), having absorbed nearly 1 billion pounds ($1.6 billion) of capital since its 2007 launch, remains stubbornly loss-making in the cut-throat U.S. grocery market where it competes with larger rivals Trader Joe's, Ralphs , Whole Foods Market and Vons.

Earlier this month Tesco, the world's No. 3 retailer, posted its first profit decline in nearly 20 years that reflected investment to address a loss of share in the UK as well as underlying sales declines in South Korea and eastern Europe.

At the same time F&E, which trades from 199, mainly leasehold, stores in California, Arizona and Nevada, posted first-half losses of 74 million pounds, similar to last year.

That put a big question mark over a target - already repeatedly pushed back - for the chain to break even in its 2013-14 fiscal year, and prompted a renewed clamour for Chief Executive Phil Clarke to call time on Tesco's U.S. adventure.

"We never liked the U.S. expansion, never thought it would work and never believe it will work, so the sooner they acknowledge this and exit F&E the better," said one of the top 25 largest shareholders in Tesco, on condition of anonymity.

Launched with great fanfare five years ago, F&E was a gamble on a new format for U.S. shoppers - a convenience store, with self-checkouts and a focus on cheaper own-brand goods.

But it is was quickly clear that Americans attached to their brands and used to customer service would not easily be won over, leading Tesco to start a series of changes and experiments - like some assisted-service checkouts and even smaller format F&E stores - that continue to this day.

APRIL DEADLINE?

Clarke, a Tesco career lifer who as a youth stacked shelves in his local store, says progress is being made and customer feedback is hugely positive, with 55 F&E stores profitable in the first half, up from 30 at the start of the year, and nearly half targeted to be profitable by the end of the year.

But though sales growth at outlets open over a year rose to 6.9 percent in the second quarter from 3.6 percent in the first, it is well down on the double-digit rates of previous years.

Tesco's share price is down nearly a quarter over the last year, and equates to just 10 times forecast earnings, versus sector averages of 13 in Britain and 17.7 in the United States.

And with the group yet to prove its turnaround plan in Britain will work, and also facing new challenges in emerging markets, investors want to see compelling evidence that it makes sense to devote even more money and management time to F&E.

"We think that the deadline is the prelims (Tesco's annual results) in April," said Panmure Gordon analyst Philip Dorgan.

Investec analyst Dave McCarthy said that, though management seemed loathe to admit it, "it seems it is preparing to exit."

YODA'S ADVICE

Clarke's strategy is to limit F&E new store openings - and thus spending - until the format is right. But his problem is that, without the rapid expansion originally envisaged, central overheads are not being spread over a larger enough number of stores, making it more difficult to reach profitability.

"While we are not setting a deadline for F&E, I do have a bit of a problem with the strategy," one of the top 15 largest shareholders in Tesco told Reuters, adding he would prefer the group either to accelerate store openings, or pull out.

"I am reminded of something Yoda says in one of the Star Wars films, 'Do or not do, there is no try'. I would be happier with them pursuing either of these strategies, in preference to the current one, but I am starting to lean slightly towards the idea of them giving up on the U.S.," added the investor.

F&E currently has a "negative worth" in most analysts' valuations of Tesco as they believe the group would have to pay any suitor to take it off its hands, and they say it is hard to see who would want to take on a loss-making operation.

Earlier this month Tesco started selling F&E products in its UK stores - a move seen by some as an attempt to improve F&E's finances by triggering royalty payments to it.

If F&E has any chance of success it needs to increase sales per store. That requires getting existing customers to spend more and enticing infrequent shoppers to come more often.

Laura Parr, a 28-year-old transcriber visiting a F&E store in San Francisco, shows what the chain is up against.

Parr has only shopped at the store a couple of times, even though it is one of the closest grocery stores to her home, and she's not impressed with the prepared meals.

"They always look really enticing and I always think they're going to taste good, but they're mediocre," she said.

The same could be said for Tesco's foray into the U.S.

* All content is copyrighted by Industry Intelligence, or the original respective author or source. You may not recirculate, redistrubte or publish the analysis and presentation included in the service without Industry Intelligence's prior written consent. Please review our terms of use.