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As Another Analyst Confirms Low Sales, Fresh & Easy Brings In More Help

Jim Prevor’s Perishable Pundit, March 20, 2008

Our extensive coverage of Tesco’s Journey to America began to attract substantial press coverage in the United Kingdom when, in pieces such as Tesco Intelligence Report: Slow Start, we pointed out facts such as these:

Here at the Pundit … we have our own unique intelligence network, and what happens is that virtually every day we receive calls and e-mails from around the industry on topics of current concern. With Tesco being of great industry concern, we receive a lot of messages regarding Tesco. In fact, we are well in excess of 200 comments, most saying nothing more than that a given industry member — a wholesaler, a grower-shipper, a broker, a consultant, another retailer — was just in a Fresh & Easy and was reporting his or her perceptions.

The vast majority of these comments contain a line similar to this: “It may just be the time of day or day of the week or perhaps just this particular store — but, there were practically no customers in the store.”

One comment, two comments, ten comments — and it could be the time of the day, the day of the week or the particular store. But so many reports, from many stores on every day of the week and from a diverse mix of times of day, seem likely to indicate that sales are not strong.

Several suppliers have also told us that orders are well below their expectations and at least some primary suppliers have thought the business not worth the trouble and stepped back into secondary supplier roles.

Although we were early, gradually other confirming information has been seeping out. We ran a piece entitled, Pundit Analysis Buttressed: Tesco’s Fresh & Easy Sales Only 25% Of Plan, Says Willard Bishop Report, in which the prominent consultancy came to roughly the same assessment we had:

The money quote:

Current performance doesn’t appear to meet initial sales projections of $200,000/store/week. Our very rough estimate is that a typical store is achieving about $50,000/week, or only 25% of initial projections.

Another prominent consultant wrote us about his assessment, and we published the letter as part of a piece entitled, Fresh & Easy Reaches Out To Shoppers As Competitors Work To Block Its Growth. This consultant included this nugget:

A source at a local Fresh & Easy who I knew in a prior position told me that the Fresh & Easy store he works at is doing $50,000 per week and not growing. Bill Bishop and the team at Willard Bishop are right on it with their sales estimate.

Then an analyst at Piper Jaffray issued a report, widely misunderstood, which basically said that it was not necessary for sales to be at such a low level for Fresh & Easy to be a big problem for Tesco. Even sales of as much as $170,000 per week would make the stores bad investments.

We analyzed the matter and press reports about Piper Jaffray’s report in a piece entitled, In London, Pessimism Spreads Over Fresh & Easy, which included this snippet:

‘The overall indication seems to be negative,’ he said. ‘This begs the questions of how bad it could be for Tesco’s Fresh & Easy stores across California, Arizona, Nevada and what it would mean to Tesco’s long-term growth rates and international strategy in the US.’

City analysts seem aware Tesco may be having teething problems. One said he had already begun referring to Fresh & Easy as ‘Ambient and Quite Difficult’. Tim Mason, who moved to the US with his family to run Fresh & Easy, recently sold £1.3 million of Tesco shares.

Said Dennis: ‘Maybe he knows what the impact of a poor US sales performance could do to Tesco’s shares in 2008, but any official explanation is probably not going to give clarity.’

Safeway’s CEO Steve Burd gave us some insight into the impact Fresh & Easy was having — or was not having — on nearby Safeway stores thus reinforcing our sales estimates. We called the piece Safeway’s Steve Burd’s Comments Buttress Pundit’s Fresh & Easy Analysis:

The “evidence” of Tesco’s volume can be deduced from a statement by Safeway CEO Steve Burd. In a piece in the East Bay Business Times, focused on a plan by Safeway to move toward “better everyday value” pricing, Steve Burd says this about Tesco:

Burd also said he’s not particularly worried about the entry of Tesco PLC, the British supermarket giant, into its home turf of California, where Safeway operates nearly 600 stores under the names Safeway, Vons and Pavilions. He said that each one of Tesco’s Fresh & Easy Neighborhood Market stores that open within 1.5 miles of a Safeway has only 10 percent of the impact of the opening of another conventional supermarket.

… Steve Burd says that the opening of a Fresh & Easy only affects a nearby Safeway by 10% of the effect that a supermarket opening has. If the square footage is 20% of the size of a supermarket, you can only get to that 10% number if sales at Fresh & Easy are half the typical sales per square foot of an American supermarket or, roughly, $50,000 per store, per week.

Now we have three things going on — all courtesy of the Times of London indicating that the rest of the world is also coming to the conclusion that there is a real problem with Fresh & Easy:

Sales at Fresh & Easy, Tesco’s first foray into the American grocery market, are 70 per cent below expectations as customers have failed to warm to the business, an analyst claimed yesterday.

As Goldman Sachs downgraded the supermarket giant’s shares on the basis of stuttering UK sales, Mike Dennis, a senior research analyst at Piper Jaffray, said that the company’s fledgeling US operation was experiencing a “substantial shortfall”.

“Fresh & Easy, Tesco’s US West Coast convenience concept is, we believe, based on our checks with suppliers in the US, running 70 per cent below budget on US sales,” Mr Dennis wrote.

Citing sources close to the company, he said that the supermarket had hoped to achieve first-year average sales of $200,000 a week per store but was averaging only about $60,000. Mr Dennis wrote that this would indicate that sales would be about $30 million in the second half, “a substantial shortfall from our initial estimate of $100 million-plus. The issue is very weak footfall.”

Translated into American English from British English, “weak footfall” means low customer count. Or exactly what we defined the problem as when we said the Pundit Intelligence Network told us that there were practically no customers in the stores.

This $60,000 number is indistinguishable from the $50,000 number we have been using. The Piper Jaffray estimate includes sales during grand opening periods — we have been using sales after the grand opening hoopla dies down.

Although the Goldman Sachs downgrade was based on problems in the UK, those problems are not unrelated to Fresh & Easy. As we mentioned in a piece we entitled British Intelligence On Tesco: Three Areas Of Concern:

Tesco’s stock is down almost 20% over the last couple of months. Wall Street will say that has nothing really to do with Fresh & Easy and, in a direct sense this is true. But indirectly, a focus on a new launch often drains talent and distracts management from its core business.

With Fresh & Easy having been launched by a dream team drawn from other Tesco operations, the implication is obvious: You can’t both put your best and brightest on a new launch and keep them at home.

And the leverage works in a crazy way. Tim Mason, who Tesco sent over to run its US division, is generally recognized as a truly extraordinary executive and a marketing genius. So let us assume he is so terrific that sales of the US stores are fully 10% higher than they would have been in his absence — what an achievement! Yet, if he was back home in the UK and his marketing savvy boosted Tesco’s UK sales by only 1% — that would be many multiples of what he is accomplishing in America — at least by measure of the company financials for the next several years.

As a leader in the UK, Tesco is always subject to a brain drain. Very possibly, by internally draining talent from Tesco’s core operation, Fresh & Easy may also be hurting UK performance.

The Times of London piece echoes these concerns:

Tesco’s investment in the United States is believed to be one of the reasons why it is struggling to match the sales growth of Morrisons and Asda in Britain.

One industry insider said that about a third of its chilled foods team has gone to America to help to develop the fresh food lines sold in Fresh & Easy.

And points to a change indicating that Tesco is starting to realize that it is in serious trouble:

The Times reported this week that Tesco had moved Jeff Adams, the American-born chief executive of the company’s Lotus business in Thailand, to the US to work under Tim Mason, Fresh & Easy’s chief executive.

Mr Dennis said that Mr. Adams is “tasked with understanding what’s gone wrong with the concept and how they are to recover, if at all, their $700 million-plus investment so far”.

Though we have never had the pleasure of meeting the man, we mentioned Jeff Adams, an ex-Wal-Mart executive, here. More curious is that none of the five current and former Wal-Mart executives we spoke with ever heard of him. So we are not actually sure what he did at Wal-Mart, but he has a good reputation as CEO of Tesco’s Lotus division in Thailand.

In press reports, Tesco is denying that Jeff Adams is being sent to do anything but support the growth of Fresh & Easy, but that seems unlikely. Either Piper Jaffray is correct and Adams is being sent in to survey the wreckage or, more optimistically, Tesco hopes another American set of eyes in a key position will help the chain.

Our take is that for such a large multi-national, Tesco seems remarkably afraid of outsiders. If it needed an American, there are plenty of competent industry executives right in the California/Nevada/Arizona area.

We never understood why Tesco sent so many top executives from other Tesco operations to begin with, thinking it created an insular culture. Bringing an American in may help — but why select one who has been living in Thailand running a Thai operation?

If the goal is operational and concept improvements, Tesco would be better off with an executive rich with knowledge of the consumer and the trade in its region. Tesco seems to value executives it trusts over executives who are experts in the American market. That is a recipe for trouble, which Fresh & Easy has plenty of.

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