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Straight Talk Needed At Tesco

Jim Prevor’s Perishable Pundit, June 4, 2009

When, after so many pieces analyzing Tesco’s journey to America as Fresh & Easy, we ran a piece titled, Tesco’s US Losses ‘Unnerving.’ It brought a thoughtful response from one of the “partners” in Tesco’s roll out:

I appreciate your well written post as always. I thought today’s was especially insightful, particularly to someone who has been working with Fresh & Easy for the past three years on the rollout of their program.

Their results are getting better since January. The basket sizes are small and their trips are growing. They are increasing SKU’s by 20% with a refit program while lowering build costs through competitive actions (vendors and consultants rebidding services and scope). I believe these measures bode well for their survival (increasing sales and lowering costs), except for the pesky issues surrounding their concept problem. Are they Aldi? Perhaps that is really where they are going but don’t know it yet. I think they are evolving in that direction.

I would challenge you on your response to Sir Leahy’s comments. How should he position the results as the CEO of a major corporation? How do other CEO’s act? I would say he does exactly what his peers do. That is, he calls the recession the problem while taking little responsibility for performance of the concept. Find another CEO that would not have it both ways. OK — Jim Sinegal, but nobody else.

It should be interesting to see how they adapt.

— John Craig
Director of Development
Drake Real Estate Services
Denver, Colorado

For those not familiar with the company, Drake is actually quite fascinating. It is called a “Neighborhood Market Preferred Developer” and has on its website links to photos of some of the Fresh & Easy stores:

Green Valley and Horizon Ridge, Henderson, NV

Centennial and Simmons, Las Vegas, NV

Tropicana and Jones, Las Vegas, NV

Nellis and Desert Inn, Las Vegas, NV

Boulder and Racetrack, Henderson, NV

Plus the company’s website posts its Fresh & Easy Marketing Package, which is apparently used to entice shopping center owners to lease to Fresh & Easy in the context of redevelopment of dated centers. Of course, most centers can’t be too choosy today, but many must have concerns that Fresh & Easy has been leasing and building stores but not opening them. Although centers like the rent revenue, even on closed stores, they also need traffic, and closed stores don’t contribute to traffic, which can weaken the entire center.

Indeed, it is interesting, perhaps even telling, that this brochure hasn’t been updated to include lots of great statistics on the power of Fresh & Easy to draw shoppers.

It is, of course, good news for Tesco if Fresh & Easy is experiencing better results — and not really surprising. Retail concepts generally go through a maturing process — as we pointed out here. With the rollout of new stores slowed significantly, Tesco benefits from this natural growth.

The problem is that Fresh & Easy started from a low base, so exceptionally large increases are required to reach the $200,000 per week per store number that Tesco had been talking about at the launch, much less the expected growth from that base.

Although John’s news that sales are going up and expenses down is certainly encouraging for Tesco, the base is so low and the losses have been so great, it will be hard to make a great success out of it.

We found John’s letter particularly intriguing, with his comments that “The basket sizes are small and their trips are growing” indicative of what we have often expressed: That a key problem is people are shopping Fresh & Easy as a convenience store, not a supermarket.

John also raises two separate and, possibly, contradictory points. He says that Fresh & Easy is expanding its range, increasing SKUs by 20%. Yet he also theorizes the company may be becoming more like Aldi. Yet if Fresh & Easy were going to become a deep discounter such as ALDI, we would expect Fresh & Easy to reduce its range so as to both simplify its operation and concentrate its buying power.

We have suggested that the right course for Tesco is to split in two, with some stores reopened as an Aldi clone and some stores reopened as a Trader Joe’s clone, so if Fresh & Easy is morphing into an Aldi it would halfway be going where we think it could. But it would seem as if a strategic decision would cost less and be obtained sooner than sort of drifting to find a place.

As far as Sir Terry Leahy’s comments go, we were merely pointing out that they made no sense. He spent the first part of the earnings conference call explaining that for a well capitalized company such as Tesco, the recession was a great opportunity as the company could build stores so much cheaper. Then he explained, in direct contradiction to what he had just said, Fresh & Easy had to slow down store openings because of the recession.

We’re not Sir Terry’s PR agent, but we do think that credibility with the investment community is important. We would worry less about “positioning” the results and more about admitting mistakes and moving on. If Jim Sinegal of Costco isn’t an acceptable model, how about Warren Buffett of Berkshire Hathaway? Here is an excerpt from the Berkshire Hathaway annual report, where Mr. Buffett explains some mistakes he made:

…there’s another less pleasant reality: During 2008 I did some dumb things in investments. I made at least one major mistake of commission and several lesser ones that also hurt. I will tell you more about these later. Furthermore, I made some errors of omission, sucking my thumb when new facts came in that should have caused me to re-examine my thinking and promptly take action….

I told you in an earlier part of this report that last year I made a major mistake of commission (and maybe more; this one sticks out). Without urging from Charlie or anyone else, I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.

I made some other already-recognizable errors as well. They were smaller, but unfortunately not that small. During 2008, I spent $244 million for shares of two Irish banks that appeared cheap to me. At yearend we wrote these holdings down to market: $27 million, for an 89% loss. Since then, the two stocks have declined even further. The tennis crowd would call my mistakes “unforced errors.”

For a CEO, honesty is the best policy. Yes, because one owes it to stockholders, and one will lose credibility on Wall Street without it. Mostly though, straight talk is wise because we may talk ourselves into believing our own propaganda — then we don’t act with alacrity to fix the situation. Then it gets worse. There is more than a little bit of that in Tesco’s Fresh & Easy saga.

Many thanks to John Craig and Drake Real Estate Services for weighing in on the issue.

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