- The document analyzes Tesco's recent financial results and strategy under its new CEO Dave Lewis. - It notes that Lewis has made progress in improving service and availability, which led to the first positive quarterly volume growth in 4 years, but that Tesco's UK like-for-like sales were still down 1% in the last quarter. - The document expresses surprise that Lewis did not explicitly mention improving quality as part of Tesco's strategy, as quality was a key part of previous turnarounds, and argues that higher quality products are important for Tesco to compete against discounters Aldi and Lidl.

1. UK Equity Ideas
Sales Offices: London: +44 20 7321 2508 Geneva: +41 58 816 86 70 Madrid: +34 91 701 57 03 Hong Kong: +852 31 98 68 60
Analyst: Tim Green +44 (0) 20 7878 4185 tim.green@mirabaud.co.uk Website: www.mirabaud.com
22 April 2015
One Tesco swallow not enough to make a high-quality summer
Tesco’s new chief executive Dave Lewis has worked hard to beat Tesco (223p) into
some kind of shape during his first seven months in the job. Given the huge legacy of
issues he has had to deal with, as well as his desire to take some radical decisions like
shutting down the awful Cheshunt HQ and moving it to Welwyn Garden City, he has
made a good fist of it so far. Throwing money and effort into first getting service and
availability up to scratch, so that he can get maximum leverage out of price cuts all
makes good sense. This has duly led to his first swallow, in the shape of the UK LFL
volume growth (1.2%) over the final quarter of last year, the first positive UK volume
figure after four years of declines. In tandem with this, UK transactions have also edged
into positive territory during the final quarter, for the first time in at least a couple of years.
This focus on volume-led recovery fits with the traditional wisdom of saving a
supermarket chain, as was ably demonstrated by Justin King when he had to pick up the
pieces as the new chief executive of Sainsbury around a decade ago. Prices will be what
they will be and the outlook for them is particularly uncertain at a time of commodity
deflation and supermarket price wars. Tesco’s UK LFL growth was still 1% negative in
the last quarter. So one needs to fix on something more immediately achievable than an
absolute sales figure, even if one hopes that the latter will come sooner rather than later.
However, there was something lacking in today’s full-year results presentation. Whilst Mr
Lewis put a lot of emphasis of the volume-driving powers of better service, availability
and price, one word was curiously absent in the presentation: quality. As far as we can
see, the word did not appear once in either the results release or presentation slides.
Now our comment may be unfair, since plans to continue a full series of range reviews
were highlighted; but the emphasis here was on cutting the number of products. We
agree with the company that the number of products was excessive and that cuts are
right, without losing the numerical, choice advantage that should give added appeal, at
least when compared to the much smaller ranges of Aldi and Lidl. But surely quality
deserves a mention too?
Perhaps, for competitive reasons, Mr Lewis is not giving too much away. The emphasis
on “reinvestment, reinvestment, reinvestment” in the customer offer - Mr Lewis’s words -
must surely include quality, we assume. Nevertheless we are rather surprised at its
apparent omission. By contrast, it was clear that a large part of the reinvestment plan
would be lowering prices, as Mr Lewis believes that Tesco’s prices are still too high
overall. However, Justin King placed the improvement of product quality at the centre of
his successful, sales-led recovery plan. Sainsbury may be different from Tesco but
quality matters.
Even a look at the accelerating success of Aldi and Lidl shows that higher quality has
been a key component of their growth, not just low prices. In their case, there has been a
sharply increased emphasis on British sourcing, for example in meat products, which has
played a key role in upgrading their own brand offer and its appeal. Cutting prices is one
thing and it obviously boosts volumes; but lower prices must also be offset by customers

2. UK Equity Ideas
Sales Offices: London: +44 20 7321 2508 Geneva: +41 58 816 86 70 Madrid: +34 91 701 57 03 Hong Kong: +852 31 98 68 60
Analyst: Tim Green +44 (0) 20 7878 4185 tim.green@mirabaud.co.uk Website: www.mirabaud.com
trading up, paying higher prices for higher quality, own brand products. This is a must for
a broad-range operator like Tesco.
One final thing to watch for, briefly alluded to by Mr Lewis in his presentation: lower
prices for food, and more recently petrol, have given customers a wodge of extra cash
but they have decided to spend it elsewhere, not at Tesco. Namely on holidays, paying
down debt or - we would add - on a host of things like cars and Sky TV subscriptions.
Indeed, look at how Sky, the young usurper, has reached level pegging with Tesco in
terms of market capitalisation – an unthinkable possibility perhaps before Tesco’s
travails. Therefore, Tesco has an urgent need to become much more relevant again to
the consumer. Although Tesco Bank is a complementary part of that effort and a more
focused effort on food will help, there is still much to prove. That doubt may also need to
be more fully discounted in the share price. There are compounding doubts to deal with,
such as sorting out the weakness in Asia and continental Europe and possible extra
charges related to the pension scheme. Tesco should be fixable - in the UK at least - and
Mr Lewis may be the person to do it. However, we are not yet drawn to consider backing
such an assessment at the current share price.
Tesco and Sky’s market cap converge (to around £18.5bn)
Source: FactSet
Tim Green
UK Equity Commentator
T +44 (0)20 7878 4185
F +44 (0)20 7930 4068
Email: tim.green@mirabaud.co.uk
MIRABAUD Securities LLP
33, Grosvenor Place
London SW1X 7HY

3. UK Equity Ideas
Sales Offices: London: +44 20 7321 2508 Geneva: +41 58 816 86 70 Madrid: +34 91 701 57 03 Hong Kong: +852 31 98 68 60
Analyst: Tim Green +44 (0) 20 7878 4185 tim.green@mirabaud.co.uk Website: www.mirabaud.com
T +44 20 7321 2508
F +44 20 7930 4068
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