I do not know whether to apologise or not for returning to the topic of Tesco – my last post on this generated some really interesting observations – given the acres of news and social media that has been devoted to the plight of (still) Britain’s biggest retailer. But the delayed half year results did provide some interesting snippets, though much of this was clouded by the revelations of the overstatement of allowances. As before however, there is much we still do not know and the saga of the allowances has probably some way to run yet (As I am writing this news comes in that the Serious Fraud Office has taken on investigating the Tesco situation, so that “probably” is now a “definitely” – another example of why this story keep on giving).
So, on the allowances/overstatement a frequent commentator on this blog, especially where Tesco is concerned commented to me by email (thanks Tarlok):
“I have put the Tesco numbers into context below hope that helps.
From an accounting and auditing perspective the prior year figures are below 5% so would be deemed immaterial and PwC can say those accounts were ‘True & Fair’ no big deal there, except they are making the adjustments to the numbers making the comparatives softer.
The current adjustment is 13% on half year and is problematic so changing the half-year numbers from forecast is right. From an accounting perspective it is about the timing of profit recognition. First half versus second half.
The buyers can always buy the stock in the second half of the year to ensure they make the annual over-rider and rebate income targets. Not sure they will get the chance to do that. ”
I think this neatly states the position and really reinforces the issues in the current year and the way they seem to have “cascaded”. Though it would be interesting to know how much of the overstatement in previous years was in the first half of each year.
I also noted a tweet tonight along the lines that “Tesco paid corporation tax on the overstated figures, which is more than can be said on any figures for some retailers”; this again suggests some other dimensions to explore. And the press today is reporting that suppliers are now looking at their figures to see what they paid to Tesco, when and whether they have implications. A quick prediction: some lawyers and accountants are going to do well out of this.
Far more interesting for me – and possibly challenging for Tesco – however, were the segment and geographical trading figures released at the same time:
International performance is problematic, though in some markets has “recovered” a little from last year. In the UK, as we know, the situation is really difficult, with only the Bank providing headline good news.
Profit has been slashed, Margin in the UK is well down, capital expenditure is reduced and focused on smaller stores. The Refresh programme covered only 262 stores in the half year (200 of which were Express stores) and will be slowed down now. When online continues to grow and convenience sales are positive then the performance in the larger stores (or some of them) in the estate must be dreadful. Market share continues to decline seemingly as well. And as for the share price ….
So for me, it is the trading question that is the fundamental issue. Yes, the allowance issue is important and who knows may lead to fraud charges, but if Tesco does not reconnect with the customers it is losing and stem the tide then where will the trading slide end? Tesco has to fight for its Christmas life, but that can only be tactical at this point one suspects, and then it has to strategically realign to stop the rot (though as I have said before, 28% market share is a good place to start, though quite what the financials are to deliver any strategy/step change is another question). Given its legacy position and the damage to its share price and likely balance sheet, room for manoeuvre may be a little limited, but the steps needed more drastic than we thought.
How does Tesco turn its power, scale and sites into something that consumers value rather than increasingly seek to avoid? And make some money at the same time from actually selling stuff? A tough ask, but not one I’d bet against from this starting point, though at what market share and what profitability it stabilises is for another time.
Your final point is the pertinent one. What I haven’t heard as you correctly point out is, “How are Tesco going to get customer numbers up and get them spending more?”. This is retailing class ‘101’. The accounting issue is a distraction from the strategic imperative, some might say convenient distraction.
The SFO intended investigation is disappointing. They need to prove that the Board (PLC) deliberately mislead the City and therefore knew the numbers were wrong for this aspect of accounting. Who was accountable? PLC board primarily: CEO (Philip Clarke – only Exec); Chairman; and Chairman of the Audit Committee who sign off on the numbers. How does a Trading Forecast get reviewed at PLC Board? Finance present last years statement plus this years numbers and suggested words at an aggregate group set of numbers. The Board finesse the words and issue. Given the numbers come from all around the World and from all types of operations Bank, Property, Mobile etc. into aggregated totals it is highly unlikely that anyone on the PLC Board would have known about this.
As for responsibility that lies deep in the buying and commercial accounting functions. Too many people and too many estimates to conclusively say this was deliberate and these folks are too distant from influencing the City! This is not a new issue, this process was around 20 years ago when I was in the Tesco Finance function.
PS Thanks for the airtime on your blog
As ever thanks for the insightful comments. At the risk of continuing to focus on the accounting and not the trading, I wonder if the SFO line is to do with the share price being “artifically” inflated – that seems to be the point of the US lawsuits mentioned in the press. Tesco have said all along there is no evidence of personal gain, but is there scope for collective gain – or collective loss? Probably far too speculative from me, and we will have to wait and see how it unfolds.
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