Tesco sales growth overshadowed by Amazon's Whole Foods move

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By James Davey

LONDON (Reuters) - Tesco , Britain's biggest retailer, reported its strongest quarterly sales growth in seven years on Friday but its stellar performance was overshadowed by news of Amazon's $14 billion takeover of Whole Foods Market .

Shares in Tesco rose as much as 4.4 percent in early trading as its first quarter trading update showed it was successfully navigating an increasingly inflationary UK trading environment.

But they ended the day down 4.9 percent as investors fretted over the implications for major supermarkets of an accelerated push by e-commerce giant Amazon into traditional food retailing.

Shares in Sainsbury's , Britain's second biggest supermarket, closed down 3.8 percent. But shares in Morrisons , the fourth biggest player, closed up 1.1 percent, reflecting an existing supply deal with Amazon.

"Incumbents to survive will need strong private label ranges, strong e-commerce operations and dominant scale to have lower costs," Bernstein analyst Bruno Monteyne said.

"Within our coverage, Tesco (has) positioned itself as the dominant player in those areas in the UK."

Tesco CEO Dave Lewis has been leading a fightback after the company's profits were hammered by changing shopping habits, the rise of German discounters Aldi and Lidl and an accounting scandal in 2014.

He stabilised the business and then got it growing again with a focus on lower prices, new and streamlined product ranges, better customer service and much improved supplier relationships. Tesco remains Britain's largest supermarket by a wide margin.

The group, which in January agreed to buy wholesaler Booker for 3.7 billion pounds ($4.7 billion), said UK like-for-like sales rose 2.3 percent in the 13 weeks to May 27, ahead of analysts' forecasts and a sixth straight quarter of growth.

"The key focus for this quarter has been working with our supplier partners to protect our customers from inflation. Today's numbers show the benefit of our approach," Lewis told reporters.

The performance was driven by 1.3 percent growth in customer transactions, 10 million more year-on-year, and by volume growth in fresh food of 1.6 percent.

PASSING ON INFLATION

Britons have been hurt by a rise in inflation, caused in large part by the fall in the value of the pound since last year's vote to leave the European Union, and by a slowdown in wages growth.

Tesco, which has a share of around 28 percent of the UK grocery market, says it is not passing on as many cost increases to shoppers as its competitors.

By purchasing a tighter range of goods and working more closely with its suppliers, Tesco is able to exploit its huge purchasing scale.

Lewis said Tesco's grocery inflation in the quarter was 1.4 percent versus the most recent measure by industry researcher Kantar Worldpanel of 2.9 percent.

"At the moment inflation in Tesco is significantly below the market trend," he said.

Tesco's finance chief Alan Stewart said the group's margin and cost savings targets were unchanged after the update on the first quarter of its financial year.

Analysts regard Sainsbury's as the most exposed to a weaker economy after its purchase of general merchandise retailer Argos.

Other analysts say the discounters remain a major threat to Tesco and its traditional rivals, highlighting renewed momentum at Aldi and Lidl, with recent industry data recording their fastest sales growth since 2015.

Tesco's group like-for-like sales rose 1 percent. But its international underlying sales fell 3.0 percent, reflecting a decision to discontinue unprofitable bulk selling activity in Thailand.

Tesco's shares have now fallen 17 percent in 2017 on concerns over merits of the Booker deal and the deteriorating UK consumer outlook.

Chairman John Allan appealed for patience at the company's annual shareholders' meeting.

"If we can see this turnaround through...we will see significantly better share prices in the future," he said.

(Editing by Keith Weir and Jane Merriman)