Chief Executive's review
“I am confident that the changes we have made make the business stronger and better prepared for the challenges that lie ahead.”
My first year as Chief Executive has been a year where we have implemented important changes at Tesco, a year in which we have built strength for the future.
It has been a year of significant change and one in which we took decisive action on some very important issues for Tesco: our reset of expectations for the UK for the forthcoming year, the announcement of our intention to dispose of our business in Japan, the focus on moving Fresh & Easy closer to profitability and the renewed focus on delivering a reliable Tesco Bank. As a part of this we made several key management changes during the year which have allowed some significant new appointments as we renew and reinvigorate the Tesco team.
This has very much laid the ground for the future; a future where we will make sure that our capital and our talent are put to work where it benefits most our customers and hence our shareholders. The future Tesco will demonstrate greater innovation and creativity as we address the needs of consumers around our world – both in store and online.
We regularly deliver over 75 million shopping trips a week and as a retailer are only as good as the last trips. Ensuring that Tesco is highly valued by customers on each and every one of those shopping trips will be what makes Tesco achieve sustainable success. That is what we set out to do every day.
I believe that we have faced into challenges with real determination and taken decisions for the future. I know that it has been a tough year to be a Tesco shareholder. I know too that my whole team and I are confident that the changes we are making are the right things to do – for customers, staff, the business and its shareholders – and that the long-term opportunities for Tesco remain undiminished.
Performance in 2011/12
We delivered modest profit growth in a challenging economic environment, with a strong international performance largely offset by a reduction in UK profits. Whilst the year gave us many things to be proud of, overall it was not the most pleasing performance. My team and I are resolved to get Tesco back to winning, particularly at home.
Group sales increased by 7.4% to £72 billion, while Group trading profit was up 1.3% on last year and underlying profit before tax rose to £3.9 billion, an increase of 1.6%. Group capital expenditure in the year was £3.8 billion. Group return on capital employed ('ROCE') increased – to 13.3% (last year 12.9%).
The Board has proposed a final dividend of 10.13p per share, taking the full year dividend to 14.76p, which is an increase of 2.1% on last year.
The decisions we have taken during the year have had an impact on our financial performance. We decided to forego some short-term profit to re-invest in the long-term health of the business, with a clear focus on improving the shopping trip for customers.
The UK business clearly did not meet our own expectations in the year and, partly as a result of this, we decided to accelerate our plan to make improvements which has meant a necessary reset to expectations for our growth in 2012/13 as well. This acceleration and reset were announced with our Christmas trading update in January.
Despite this significant re-investment programme, we remain committed to driving higher returns for shareholders. Although our investment plans in the UK make achieving our ROCE target more challenging in the short term, we still expect to deliver a ROCE of 14.6% by 2014/15, with broadly based growth from around the Group.
Philip in conversation with Ellen and Jobe at the Tesco Extra store in Baldock
Building for
the future
Related information
Strategic update
In last year's Annual Report, I set out an evolution of our strategy into seven parts:
This strategy remains as relevant now as it did a year ago and I'm pleased to be able to update you on the progress we have made on each of these strategic objectives. I also set out immediate management priorities for the business last year – keeping the UK strong and growing; becoming outstanding internationally, not just successful; becoming a multi-channel retailer wherever we trade; delivering on the potential of retail services; applying Group skill and scale; and delivering higher returns. You will see how these priorities have shaped our actions through the year.
To grow the UK core
In the UK, high petrol prices and falling real incomes affected customers' discretionary spending in the year. The combination of disappointing sales in the second half of the year and our decision to increase investment into the shopping trip meant that our UK performance was weaker than planned. Sales grew by 6.2%, supported by excellent new store performance, but trading profit declined by (1.0)%.
The issue we are addressing is that the shopping trip just hasn't been improving fast enough and our standards haven't been as consistent as our customers have come to expect. As a result, we are taking action to improve each aspect of the customer offer. This will involve significant revenue and capital investment in a comprehensive plan encompassing six key areas.
The UK Plan – Building a Better Tesco
Our Plan for the UK business has six elements:
Service & Staff: helping our people deliver great service by investment in recruitment, training and equipment, dedicated to particular departments such as produce so that our customers notice the change.
Stores & Formats: making our stores better places in which to shop and work, with the pace of new store development moderating, and the pace of refreshing our existing stores stepping up.
Price & Value: delivering great value for money through the right blend of price, promotions, couponing and loyalty.
Range & Quality: building the right ranges of quality products, reviewing and refreshing our entire range of Tesco brand products, making our ranging more store and format-specific, and bringing dunnhumby, our marketing insight business, back into the heart of Tesco.
Brand & Marketing: making sure that we get back to having the right conversation with our customers about Tesco.
Clicks & Bricks: making this a potent combination for our customers, with the roll-out of Click & Collect and the transformation of our range and online presence.
We are clear on what we need to do, we have trialled substantial elements of the changes and we know they work. Our investment programme has already started and we expect this to deliver stronger results. The Big Price Drop in September 2011 was the first step, but the changes we are making are about much more than price. They are a combination of price, quality, range and service, including a significant investment to create an additional 20,000 jobs over the next two years. These changes will reinvigorate the shopping trip for customers, and consequently deliver improved performance for shareholders.
The deli counter in our Hertford Superstore has a flat glass front, bright lighting and warmer, more engaging signage
To be an outstanding international retailer in stores and online
Our international businesses performed strongly, with trading profits up 18%, or by 22% before the impact of a crisis tax levied in Hungary. We have seen progress in our established businesses, such as in Central Europe, South Korea and Thailand, and from our newer, rapidly growing businesses, such as Fresh & Easy in the United States and Tesco Malaysia. It is encouraging that we are winning market share in almost all of our markets and, in some countries, at a faster rate than for many years.
I am pleased with the performance of our businesses in Asia. Sales and profit grew well – sales by over 10%, and trading profit by over 20%. We delivered solid like-for-like sales growth and an excellent contribution from new stores.
Our business in Thailand had an extraordinary year. The worst flooding for 70 years caused us to close over 150 stores temporarily and all four of our distribution depots. The superb dedication of our team enabled us to keep supply lines open for customers and to support staff affected by the flooding, and we have come out of the crisis stronger. We grew like-for-like sales and profits in the year. South Korea had another good year, although I anticipate a modest reduction in like-for-like sales next year as restrictions on trading hours for large retailers are implemented across the country.
In China, we have continued to focus on building scale in three regions of the country. With the economic environment currently proving challenging for mainstream retailers, we have decided to take a more cautious stance on the market, at least for now. We have decided not to commit substantial new capital to freehold shopping centres, and we have also elected to hold back on the pace of new hypermarket development this year. We will only open 16 stores, instead of stepping up as we had planned. We still believe that China can be an engine of growth and we can speed up again when the outlook improves.
We took an important step this year in deciding to exit Japan. It is right to focus on our larger, profitable and growing businesses in the Asia region. It is never easy to make decisions of this kind and I would like to thank our staff in Japan for their continued hard work and professionalism through this time.
Following a strong performance in Europe in the first half of the year, the performance in the second half was weaker than expected. Sales for the year grew by 8% and trading profit increased marginally, by 0.4%. Trading profit growth would have been in line with sales had it not been for the impact of the crisis tax imposed in Hungary, which cost £38 million in the year.
The economic background was particularly difficult in Hungary and in the Republic of Ireland this year. Given the current conditions, we are focusing on growth primarily through our existing stores in these markets, rather than investing substantial new capital. In addition to these headwinds in two of our largest markets, profits were held back by disruption connected to the opening of our new distribution centre in Poland, but this is behind us now.
We have made good progress with the closer integration of our European businesses this year, from sharing infrastructure to buying as a single region. This means that we can leverage the skill and scale of the Tesco Group to deliver a better shopping trip for customers and higher returns for shareholders. One example of this is our recent launch of grocery dotcom in Prague, with initial sales well ahead of plan, and our dotcom business in Warsaw will be launched soon.
It has been a year of encouraging progress in Fresh & Easy. Sales grew by 27%, with almost 12 percentage points coming from like-for-like stores. We have also delivered reduced trading losses for the first time, with an 18% improvement on last year. After four years of rising losses, this is a decisive change of trend, driven by further improvements to our customer offer. Features such as in-store bakeries, more loose produce, additional ranges and new Fresh & Easy products have been very popular with customers and we have seen an acceleration in our already strong growth in customer numbers.
The progress we have made gives us more confidence that we will deliver a further significant reduction in losses in the coming year. The timing of break-even will be later than we had previously expected, as we will focus on getting more of our existing stores to reach profitability before we step up the rate of new store openings. We can then reach sufficient scale to cover our substantial central overhead costs and we anticipate that we will reach the break-even point during 2013/14.
Our Extra format stores delivered an encouraging performance through the year
To be as strong in everything we sell as we are in food
It has been tough to achieve growth in sales of discretionary items – not least in the UK, where we have seen a number of specialist general merchandise retailers go into administration – and our UK like-for-like growth in general merchandise, clothing and electricals has remained negative. To adjust to this, we have been allocating more space to the most popular products and improving merchandising. We are committing less capital to new space for non-food and instead focusing more resource on continuing to develop our online capability.
Europe and Asia delivered stronger performances in general merchandise, clothing and electricals, despite subdued consumer confidence even in the better performing economies. I was pleased with the performance of clothing in Central Europe, with sales growing by 12% at constant exchange rates. This is testament to the strength of the F&F brand and also to the performance of our new Extra format stores. We ended the year with 44 of the new Extras in Europe and three in Asia. These stores are introducing our customers to a different way of shopping, with stronger ranging and new services, with extremely encouraging results. Different categories of food and general merchandise have their own distinctive look and feel within the Extra store, known as 'Worlds', such as Baby World and Sports World. We are making similar changes to the look and feel within our large UK stores, partly as a result of the encouraging performances in Europe.
Baldock Extra Electricals department. We are seeing the early benefits of our changes, but much remains to be done
To grow retail services in all our markets
Tesco Bank is a key part of the potential we see in retail services. Since we took full control of the Bank in 2008, our focus has been on developing our own systems and infrastructure and recruiting and developing a new team to run the operation. I'm delighted to say that this period of migration from The Royal Bank of Scotland ('RBS') to our own platforms is now nearing an end. Building a bank is a complex task and I took the decision during the year to slow down the migration, so as to minimise the customer impact. This final stage of migration will be completed imminently, at which point the business can put more emphasis on growth and on developing the potential we see in financial services.
We have delivered good business growth in the year with revenue up 14%, driven by a good performance in the insurance business. The Bank's profit figure includes several accounting adjustments, so we measure business performance using baseline profitability, which increased by a very encouraging 29%. The Bank's capital position has also remained strong through the year, supported by a 7% growth in savings balances.
With the migration almost completed, the Bank is well positioned for future growth. We are also on track to launch new products, starting with mortgages, to broaden into a full-service retail bank.
Customers can purchase insurance and other Tesco Bank products in store, alongside their weekly shop
To put our responsibilities to the communities we serve at the heart of what we do
We have reinforced our commitment to be a good corporate citizen this year: as a retailer, an employer and a neighbour. We employ over half a million people worldwide, which allows us to make a real difference in the communities where we operate. Our core business involves two vital roles in the heart of the community: providing customers with safe, good quality, affordable, nutritious food and creating good jobs and careers. Beyond this, we have demonstrated that we put our responsibilities to communities at the heart of what we do in a huge variety of ways: I want to pay tribute to just some of the great achievements of the last year.
Even when their own homes were in danger or flooded, our people in Thailand went to extraordinary lengths for customers. Some even gave up their days off and travelled for hours by boat to continue to get essential supplies to our customers. There is no better example of our colleagues living true to the Tesco Values: 'No one tries harder for customers' and 'Treat people how we like to be treated'.
Our responsibility to our people is to provide them with good jobs and careers. In the last year, we have created thousands of jobs across our businesses, invested in a state-of-the-art, zero-carbon training academy in South Korea and have continued our work in the employment of young people, university graduates and the long-term unemployed.
Our customer offering is based on strong relationships with our suppliers. For example, we now have supplier academies in all of our Central European markets for suppliers to present their products to our buyers. This enables us to support the growth of our suppliers whilst sourcing the best local and regional products for our customers.
Any business on the scale of Tesco has the opportunity to make a significant difference in tackling climate change. We were proud to be recognised by the Carbon Disclosure Project again this year, with Tesco named the top retailer in the world. We will continue our work as we progress towards our ambitious target of being a zero-carbon business by 2050.
Our state-of-the-art, zero-carbon training academy in South Korea, to train staff from across the Tesco Group
To be a creator of highly valued brands
Across our markets our own-label programme encompasses a broad spectrum of ranges to appeal to diverse customer needs, giving customers the quality products they are looking for at competitive prices.
In the last year we have expanded our offering, launching new ranges such as Venture Brands in the UK and Europe – including Chokablok chocolate and ice cream and Carousel children's toys – which offer customers premium quality at great prices.
We have started to differentiate our ranges more clearly, such as our sub-brands Gourmet and Eat Well in Fresh & Easy and Goodness, which is a range of healthy and nutritious children's products now also available in the UK.
We recently relaunched our UK Tesco Value range as Everyday Value, with quality improvements to hundreds of products and new, brighter packaging. This is the first stage in a refresh of our entire range of over 8,000 Tesco brand products in the UK in the next two years, including a comprehensive update to our Tesco Standard range.
This is an area of substantial and growing strategic importance for us, as we recognise the role that our brands play in attracting customers and as we start to leverage our expertise in brand management across our markets.
Finest sold well over £1 billion in the UK alone this year. In April 2012 we relaunched Tesco Value as Everyday Value, with quality improvements to hundreds of products
To build our team so that we create more value
Strengthening our management
This time last year we were in the early days of some of our new management structures. I had just introduced a matrix structure throughout Tesco with CEOs for each of our key business areas – the UK, Asia, Europe, and the US – supported by integrating functions, such as Property, Human Resources and Marketing. I am very pleased with how this structure has bedded in and expect to see even greater value creation as a result.
The introduction of a dedicated UK Operating Board has enabled greater focus at home and given the importance of the changes we are currently making for customers, I have recently decided to assume direct responsibility for the UK business during the process of its renewal.
I have continued to strengthen both the Executive Committee and our senior management teams through the last year, drawing on our deep pool of internal talent.
We have also been fortunate to welcome our new Chairman, Sir Richard Broadbent, following Sir David Reid's decision to retire. I want to thank David for his lasting contribution to Tesco over 26 years on our Board and, on a personal level, for all the help he has given me in settling into my role as CEO.
Building the Tesco team
Tesco's most important asset will always be its people, who live by our Values to do their very best for customers. Many of our plans for the coming year are built on investment in our people. We employ more than half a million people across the globe and this will continue to increase, with plans to create an additional 20,000 jobs in the UK alone in the coming two years and to continue to grow our teams around the world. It is the quality, commitment and dedication of our people that gives me so much confidence that we can and will achieve our plans for the years ahead.
We will create 20,000 more jobs in the UK over the next two years and many more around the world
Delivering higher returns
In April last year we set out a target to increase our already good level of ROCE to 14.6% by 2014/15. We improved ROCE from 12.9% to 13.3% in 2011/12. Although it is likely that we will see a small reduction in 2012/13 as a result of our UK investment plans, we continue to see a number of opportunities to drive returns and we still expect to deliver our targeted increase to 14.6% by 2014/15.
Doing the right thing
I am confident that we are ready to tackle whatever challenges lie ahead. The decisive action that we have taken in the past year and the management changes which have reinvigorated the Tesco team have laid the ground for the future; a future where we will make sure that our capital and our talent are put to work where it benefits most our customers and hence our shareholders. We have and will continue to focus on doing the right thing for customers, for communities, for staff, for the business and for our shareholders.
Philip Clarke
Chief Executive
