As Tesco make its big push into non-food retailing this week we take a look at the prospects for Britain's biggest grocer.
Tesco
(LSE: TSCO)
has probably been one of the most aggressive price cutters amongst British grocers. But price cuts may eventually deliver, at best, only marginal benefits to shoppers as trimming prices becomes increasingly difficult. Worst still, it may even eat into the company's profits if further price cuts are not adequately compensated by top-line sales growth.
Therefore, it is not entirely surprising that Tesco is looking at other options. These include overseas expansion, and developing new channels that may offer it lucrative opportunities to grow.
Overseas expansion seems a no-brainer given that Tesco can transpose its winning retail formula into untapped markets. Currently, it operates in ten European and Asian countries, and international annual sales of around £10 billion account for roughly a quarter of group sales.
Recently, Tesco said it was on track to deliver its largest ever programme of international stores openings this year. Some six million square feet of new store space will be added with a further one million square feet added through the acquisition of 11 Carrefour stores in the Czech Republic.
Not content with its current portfolio of international interests, which has seen sales grow at 15%, Tesco is now eyeing up the US. It recently said it plans to roll out a chain of convenience stores called Fresh & Easy on America's west coast. This will be based on its existing Tesco Express concept, though the US stores are expected to be three times bigger than their British counterparts.
Apart from expanding overseas, Tesco also plans a big push into non-food retailing in Britain. Over 8,000 products will soon be available through Tesco Direct, which kicks off trading this week. The housewares catalogue is expected to pose a major threat to Argos, which is owned by GUS
(LSE: GUS)
, and Ikea. What's more, according to market research firm Verdict, the new venture may lift Tesco's share of the non-food market above Argos to 3.6% by the end of this year.
Initially, clothing won't be available through Tesco Direct, but it is something that the company said it is considering. Hence, this may present a major challenge to clothing companies such as Next
(LSE: NXT)
and Marks & Spencer
(LSE: MKS)
, which recently announced plans to venture into selling electrical items.
Taken together, sales growth through Tesco's various ventures is expected to lift group revenues 8% to £42.6b in 2007, and by a further 8% to £46b the following year. According to latest estimates, Tesco is expected to report a 9% rise in pre-tax profits to £2.4b in 2007. This values the company at 17 times earnings, which at first sight appears expensive.
However, let's not forget that Tesco has doubled in size in five years. At the turn of the Millennium, the company was worth £15b, and today it boasts a market value of £30b. This equates to a compound growth rate of around 15% a year, which puts its lofty valuation into perspective.
That said, Tesco has never ventured in to the US before. And many British companies that have expanded into America have also returned with their tails between their legs. They include Marks & Spencer, Sainsbury
(LSE: SBRY)
, Emap
(LSE: EMA)
and Allied Irish Bank
(LSE: ALBK)
. Of course this time it may be different. Nevertheless, spending £250m a year on a US venture strikes me as being risky when there are safer pickings closer to home.
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