WASHINGTON, June 30, 2011 /PRNewswire/ --
-With photo
The CtW Investment Group is calling on incoming Tesco (LSE:TSCO)
Chairman Richard Broadbent to
address investor concerns about mounting losses at Tesco's Fresh
& Easy subsidiary by conducting an objective and independent
strategic review of the U.S. business and to publicly articulate a
strategy for profitability.
In its 29 June letter, the CtW Investment Group also notes that
under the new remuneration policy, U.S. CEO Tim Mason's incentive pay will be substantially
de-linked from Fresh & Easy's performance, raising questions
about executive accountability for continuing losses in the U.S.
The CtW Investment Group also points out that all executive
directors will continue to have their incentive pay linked to
profits from the sale and leaseback of property, which may
potentially allow executives to "pick their number" in order to hit
performance targets.
The CtW Investment Group's 29 June letter to the Tesco
Chairman-elect is below and can be found at
http://www.ctwinvestmentgroup.com:
June 29, 2011
Richard Broadbent
Chairman-elect
Tesco PLC
c/o Barclays PLC
1 Churchill Place
London UK E14 5HP
Dear Mr. Broadbent,
We call on you, as the incoming Chairman of Tesco's board of
directors, to lead the board in an objective and independent review
of Tesco's Fresh & Easy operations in the U.S., and to publicly
articulate a strategy to deliver on the company's repeated promise
that Fresh & Easy will "break even" by 2013 (and presumably be
profitable thereafter).
We believe that the board must undertake this strategic review
not only because Tesco's existing approach to the U.S. market has
been notably unsuccessful, but also because, with the changes made
to the Tesco executive remuneration policy by the Remuneration
Committee, the Fresh & Easy CEO, Tim
Mason, no longer has his remuneration tied directly to the
performance of U.S. operations or to the achievement of expansion
milestones.(1) The original purpose, as stated in 2007, of adding
U.S. award objectives to Mr. Mason's pay package was to incentivize
the U.S. CEO to deliver a strong and profitable U.S. business in a
challenging retail environment. Given that Fresh & Easy
remains unprofitable and that the U.S. retail environment remains
challenging, it appears Tesco has simply dropped the idea of
linking executive performance pay to the performance of the U.S.
business in any meaningful way.
Since Mr. Mason has been responsible for leading Tesco's efforts
in the U.S. market since their inception, delinking his pay from
Fresh & Easy eliminates the primary mechanism through which
Tesco executives were in any transparent way held accountable for
poor U.S. performance. Of course, as we have pointed out in
letters to your predecessor and current Chairman David Reid, in practice it appears that Tesco
did not meaningfully hold Mr. Mason - or any other Tesco executive
- accountable for Fresh & Easy's substantial and ongoing
losses, and instead "moved the goal posts" to enable Mr. Mason to
enjoy handsome remuneration despite Fresh & Easy's evident
struggles. This year, for example, the Remuneration Committee
awarded Mr. Mason a bonus worth 80% of his salary even as the U.S.
results disappointed and trading losses increased for the third
consecutive year.
Additionally, our communications to Mr. Reid argue that overall
executive remuneration at Tesco appears to have been inflated by
the inclusion of property profits from sale-leaseback transactions
in the performance measures (particularly EPS) used in Tesco's past
executive pay plans. In our most recent letter, we noted that even
a shift to Return on Capital Employed (ROCE) as a performance
measure would not ameliorate our concern that executives can "pick
their number" and undertake more or fewer sale-leaseback
transactions in order to hit their targets.
The CtW Investment Group works with pension funds sponsored by
unions affiliated with Change to Win, a coalition of U.S. unions
representing nearly five million members. These funds have over
$200 billion in assets and are
substantial long-term Tesco shareholders.
We outline our concerns below.
Fresh & Easy's Continued
Struggles
"I look at the plans and the plans
are persuasive. But…there is a big shift required if we are not to
get to your doomsday scenario and a billion [pounds] of accumulated
losses. Now, the plan doesn't say that, so deliver the plan."(2)
Philip Clarke, Tesco CEO
Ever since Tesco's first stores opened in the U.S. in
November 2007, the company has
claimed that the reception by U.S. consumers has been very
positive, and that profitability was just over the horizon. Despite
these claims, as Figure 1 shows, Fresh & Easy's trading losses
have increased every year, even as sales have grown.
(Photo: http://photos.prnewswire.com/prnh/20110630/DC28785)
These losses raise questions about the Fresh & Easy business
plan and its implementation. The U.S. business has
consistently failed to meet expectations: In fiscal 2008/2009
losses from U.S. operations were 142 million
pounds Sterling, or 42 million pounds higher than projected.
The following year U.S. losses climbed to 165 million pounds even
though the company had expected a "similar loss" to what was
experienced in the prior year. In 2010 Tesco said it believed
that Fresh & Easy losses had peaked; however in 2011, the
company once again reported higher than expected losses of 186
million pounds. The number of store openings has also fallen
considerably behind the Company's projections.
Tesco has frequently suggested that Fresh & Easy's losses
should be attributed to the considerable start-up costs associated
with Tesco's first major commercial venture in the U.S. For
instance, in its 2009 Annual Report, the company asserted that it
would achieve profitability after opening 300 U.S. stores.
However, not only has the pace of expansion in the U.S.
slowed sharply, but the increases in scale that have been achieved
do not seem to be delivering improvements in profitability.
Table 1: Fresh & Easy Growth Not On
Target (Pounds Millions)
Change in Trading
Change Change
Change in Sales per Profit
per
in
in Trading Marginal
Marginal
Stores Sales
Profit Store
Store
146.00 -23.00
2009/2010 30 pounds
pounds 4.87 pounds -0.77 pounds
148.00 -21.00
2010/2011 19 pounds
pounds 7.79 pounds -1.11 pounds
--------- --- -------
------- ----------- ------------
As Table 1 illustrates, while Tesco's newly opened stores over
the past year have been associated with an overall increase in
sales per store, they have also been associated with increasing
losses per store. Tesco is projecting that Fresh & Easy will
"break even" sometime in the 2012/2013 fiscal year, without any
clear indication of why shareholders should have confidence that
this goal will be met. Given that increases in scale so far seem to
have done little to improve profitability, we are skeptical that
the current strategic approach can achieve even its relatively
modest goals in two years time.
This skepticism about Fresh & Easy's prospects finds support
in the published views of many analysts following Tesco, who point
to the substantial challenges Fresh & Easy faces in winning
over U.S. consumers and generating a return on investment
commensurate with the Tesco's large U.S. investment.
More specifically, analysts have questioned whether
like-for-like growth at Fresh & Easy is driven mainly through
extensive use of discounts and promotions, such as $5 off coupons, which represent a substantial
percentage of average customer purchases at small format stores
such as Fresh & Easy. Mike
Dennis of MF Global questioned the wisdom of opening stores
in Northern California that are
supplied by daily deliveries from the company's distribution center
in Riverside, located hundreds of
miles away. Others have questioned the heavy reliance on
in-house brands in a supermarket culture where the private label
offer is widely considered to be inferior in quality.
Crucially, while Tesco has clearly made its share of mistakes
entering the highly competitive U.S. retail market, it has
compounded its errors by alienating some stakeholders, including
vendors and their trade groups, community organizations, Fresh
& Easy employees and trade unions. For example, the
respected "Perishable Pundit" blogger Jim
Prevor has written, "Tesco elected to alienate many
suppliers when it broke the produce trade's cultural pattern by
refusing to join trade associations…" (3) Prevor has also published
extensive commentary from industry members highly critical of
Tesco, such as:
"…one reason everyone is so interested in Tesco's
adventures is because of the way they treated the potential U.S.
suppliers and the market place. When suppliers were interviewed,
there was a level of arrogance and bullying that most of us hadn't
seen since we were on the playground in grammar school."(4)
Rather than spend two further years on a strategic trajectory
that does not appear promising for numerous reasons, we believe
that the board must undertake an objective review of U.S.
operations, and determine what changes in strategic direction are
necessary to turn Fresh & Easy around.
As part of this review, we urge the board to meet with key
stakeholders - including consumers, vendor associations, community
leaders, elected leaders and representatives of organized labor -
in the areas where Fresh & Easy has established operations, in
order to ensure that it is fully informed of the public perception
of Fresh & Easy, and any obstacles this perception may present
for future growth. While Fresh & Easy is currently only a small
portion of Tesco's overall operations, the U.S. market clearly
presents enormous growth potential for Tesco if it can adopt a
viable strategy going forward.
Property Profits and Executive
Remuneration
As we explained in our May 16,
2011 letter to Mr. Reid, we are concerned that over the past
several years, but especially following the 2008 financial crisis,
a disproportionate and growing share of Tesco's profit before tax
has been generated by sale-leaseback transactions. Since profit
before tax is a key determinant of overall earnings and earnings
per share, it appears to us that even with Tesco's adoption of a
new remuneration plan focusing on group-wide ROCE, executives could
have the ability to "pick their number" and undertake a higher
quantity of sale-leaseback transactions in years when core retail
operations have not generated the earnings necessary to hit
remuneration plan targets.
Other analysts have questioned the use of property profits in
determining executive pay levels. For example, in its recent
analysis of remuneration at Tesco, PIRC asserted that mature
property sales are not "indicative of sustainable operational group
performance," and that including property sales in metrics to
determine bonus pay outs under the long term performance scheme "is
not appropriate." (5)
As we have stated in the past, we continue to urge the board to
clearly distinguish retail profits from real estate profits, and to
base remuneration solely on the former. Since transmitting our May
letter, we have noted that Tesco has committed to keeping property
profits within a range of 250M pounds to 350M pounds (i.e., below
the level of the past two fiscal years). However, as far as we are
aware, Tesco has not disclosed any change in practice with respect
to counting such real estate profits toward executive remuneration
targets, and so our concerns remain. We enclose a copy of our
May 16, 2011 letter to Mr. Reid for
your review.
We understand that as a newly incoming director and Chairman,
you may feel chary of immediately challenging the strategic
decisions taken by incumbent managers and your fellow board
members. Nevertheless, we urge you to do so in order to ensure that
Tesco shareholders fully support the company's executive
remuneration arrangements and have confidence in the best position
possible to realize the potential of U.S. expansion. If instead
Fresh & Easy continues to stagger along with mounting losses,
we fear that Tesco may abandon the U.S. market and leave its
considerable potential untapped. In our view, that outcome may be
avoided by a timely assertion of your role as Chairman in providing
much needed strategic advice to management on a critical but
troubled long-term investment.
Sincerely,
William Patterson
Executive Director
cc: Tesco PLC Board of Directors
** Note: For additional information or comment please
contact Ed Keyser at
edward.keyser@changetowin.orgor at
+1-202-721-6063. **
CONTACT: Ed Keyser (US),
00-1-202-721-6063
(1) Tim Mason is not a member of
the Tesco PLC Remuneration Committee. The company states that
"no member of the [Remuneration] Committee has any personal
financial interest in the matters being decided…nor any day-to-day
involvement in running the business of Tesco." Tesco 2011
Annual Report p. 75. Tim Mason was
recently appointed Deputy CEO and Chief Marketing Officer of Tesco
in addition to his continuing role as President and CEO of Fresh
& Easy.
(2) Financial Times, "Leahy planned for 10,000 Tesco stores
in US," 9-19-2010.
(3)
http://www.perishablepundit.com/index.php?date=02/27/09&pundit=4
(4)
http://www.perishablepundit.com/index.php?date=03/12/09&pundit=1
(5) PIRC Alerts, 6-21-2011, p.1.