Following on from the debacle at Tesco, Sainsbury produced some quite awful trading figures yesterday (1/10/2014). Here’s a review of some of the news on those and other retailers.
Tesco
The Financial Conduct Authority (FCA) are undertaking an investigation into Tesco’s “overstatement of expected profit”. Making misleading statements to the market is potentially a criminal offence. How long that will take to reach any conclusions is anyone’s guess. The result of such investigations are often reported to investors so late in the day that they are of little consequence. Hopefully something will come out sooner from the company as a result of their own investigation (they have employed Deloitte to do this).
Private Eye made some interesting comments on the affair. They pointed out the large figure of £4.7m that PwC, Tesco’s auditors, earned from non-audit work at the company last year – almost as much as the audit fee. Many investors feel that auditors should be prevented from doing non-audit work for a company they audit, typically consultancy and tax advice, but auditors and companies have both opposed such a restriction. The US imposed severe restrictions on non-audit work by auditors after the Enron scandal where Arthur Anderson appear to have suffered from a conflict of interest. It is suggested that large payments for non-audit work prejudices the views of those reporting on the audit and make it more difficult for them to challenge the company.
Private Eye point out that the Financial Reporting Council is chaired by a former audit partner of PwC, and their director of codes and standards is also a former PwC partner. The Competition Commission did look at the Audit market last year but ruled out mandatory auditor rotation and did not even consider the question of non-audit work. It is regrettably true that the accounting and audit regulations in the UK tend to be set by accountants and those in Government departments who come from similar backgrounds with little input from investors.
It has been suggested to ShareSoc that we form a shareholder action group to promote the interests of investors in Tesco (it is of course widely held by retail investors). What might be the objective though? To obtain a change of auditor (assuming they are shown to have been deficient in some regard), to stop non-audit work going to the audit firm, to change the management (they just got a new CEO), to make claims against the former management or ask for bonuses to be retrieved or cancelled, to change the Chairman or other non-executive directors, or other objectives. Anyone who thinks such a pressure group might be advantageous should contact ShareSoc.
Sainsbury
Sainsbury’s trading statement was very disappointing. Like-for-like retail sales for the first half of the year were down 3.4 per cent. Fuel prices partly depressed the figure, but even ignoring those they were down 2.1 per cent with the second quarter worse than the first. The real killer for the share price was the statement that they only expected the second half to be similar to the first half. In other words this was not a temporary short term impact that the management had a quick response to and knew how to tackle. It showed a more fundamental underlying trend and that the price war among supermarkets will likely continue for some time.
It is no secret that discount supermarkets such as Aldi and Lidl are eating the lunch of the more traditional UK supermarkets – for example Aldi UK pre-tax profit rose 65% to £260.9m in the year ending 31 December, with sales from UK stores open at least a year up 30%. The growth in their market share is truly astonishing because most of it must come not from new store openings but from diverting those consumers who traditionally do their shopping in Tesco, Sainsbury, Morrison, Asda and others.
Unfortunately food retailers are operationally quite highly geared. They have a lot of capital tied up in shops, and high commitments on retail property leases. Reducing costs is not easy if sales volumes fall because it’s not easy to reduce store sizes and cutting staff can affect customer service. Sainsbury might have some advantages in that they have fewer mega stores, but it is clear that they and Tesco have been damaged by the trend by shoppers to go for basic products at lower prices. Supermarkets have been making hay for some years by selling shoppers “luxury” products at superior prices to consumers who barely notice the prices of what they pick up, while promoting a few “basic” products at discounted prices so they look competitive.
But the key business lesson is that in essence supermarket shopping is a sector with few barriers to entry. Shopper loyalty is ephemeral and the prevalence of “loyalty card” systems has not stopped customers drifting away to other stores. The cash advantage of these loyalty schemes to shoppers is in reality quite small. Store differentiation and service differentiation is likewise minimal – one store looks very much like another.
So this is why these businesses, and investors in them, have come a cropper. New companies have seized the opportunity of pressure on consumers budgets. Following frozen income levels in recent years for a lot of the population, the discounting retailers have established a somewhat different business model and gained large market shares all of a sudden. Consumers have also perceived the rising costs of their weekly supermarket shopping as being down to clever tactics by the conventional retailers, and they could be right there.
These competitive issues are not prone to a quick and simple solution. Simply cutting prices on a few items will depress profits without tackling the underlying issue and still make them uncompetitive with companies that have a more limited product range and simpler support requirements. That is why there will not be any quick solution for Tesco and Sainsbury’s profit problem, and why Sainsbury’s are holding a “strategic review”.
Sainsbury’s share price fell 7% on the day of their announcement, Tesco fell 3% in sympathy and Morrisons fell 4.9%. Even non-food retailers such as Topps Tiles and Carpetright seemed to be affected by this malaise. Retailers appear to becoming revalued by the market now that the risks they face are suddenly becoming more apparent and they can no longer be relied on to produce their once very predictable profits.
Roger Lawson
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