Will Tesco plc Ever Return To Multi-Billion Pound Profits?

The heyday of Tesco (LSE: TSCO) was in the noughties. With chief executive Sir Terry Leahy at the helm, the Tesco juggernaut rolled on from year to year, making multi-billion pound profits and dominating grocery retail in the UK.

It reached a market share of over 30% of the supermarket sector and of every £7 spent in-store in Britain, £1 went through Tesco’s tills. It had enviable margins and it built out-of-town superstores and local mini-marts as it expanded across the company on expectations that the good times would keep on rolling. It also grew businesses overseas, from the US to Eastern Europe, Thailand and Korea. Its aim was to rival other international retail giants such as Walmart and Carrefour.

Increasingly crowded supermarket sector

Analysts fawned over the company, and explained to potential investors that Tesco’s scale meant that it had greater buying power than any other retailer. That was why it was making such huge profits.

At the time, a philosophy of build it and they will come pervaded retail in the UK, and there seemed to be no limits. But, after the Credit Crunch, the cracks started to appear. Customers suddenly started to spend less, and tended to go for cheaper brands. At the same time, the retail space had become increasingly crowded, as chains such as Aldi, Lidl, Marks & Spencer and Waitrose continued to expand while online newcomers started to change the way Britons shopped altogether.

Tesco’s profitability suddenly crashed, and with it the share price. A more crowded market meant sales were falling. So Tesco took drastic action, closing stores, jettisoning the unprofitable US business, and then also the profitable South Korean arm. Instead, it has invested more in its home market in the UK.

Recovery has a long way to go

We’ve begun to see the fruits of this strategic shift. The latest company results have shown increasing sales. After a year when Tesco made a horrendous £6.4bn loss, proving that just as its profits were once bigger and anyone else’s, so could its losses be, it managed to report an annual pre-tax profit of £162m.

That’s encouraging, but you have to consider that in 2014 its earnings were £1.9bn. What’s happening is that Tesco is investing billions in strengthening its UK business. This has led to those recovering sales. But this investment means that it hasn’t returned to the multi-billion pound profits of its glory days.

In fact, my view is that in a changed retail landscape, Tesco will never return to making those multi-billion pound profits. That’s why I’m still not investing in this company.

I think Tesco’s ambitions are actually more modest now. It will try to maintain its market share in the UK, while avoiding cutting thousands of jobs. Its profitability will gradually recover. And it will grow overseas more through partnerships than through expensive standalone ventures. But this is a turnaround that has a long way to go yet.

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Prabhat Sakya has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.