Tesco shares hit as international pressures overshadow UK growth

By James Davey

LONDON (Reuters) - Weak trading in Thailand and Poland took the shine off accelerating sales growth in Tesco's main UK business, with shares in Britain's biggest retailer falling sharply after it missed first-half profit forecasts.

The company, being rebuilt by Chief Executive Dave Lewis following a 2014 accounting scandal, unsettled investors as problems abroad compounded fears that competition at home would intensify with the planned merger of its closest rivals.

The group, which stuck to its medium-term targets, reported underlying operating profit of 933 million pounds ($1.21 billion) - up 24 percent on last year but short of the 978 million pounds analysts had expected.

Profit fell 29.1 percent in Asia and by 3.3 percent in central Europe, partly offsetting growth of 47.6 percent in the UK and Ireland where it has benefited from its acquisition of wholesaler Booker in a 3.7 billion pound ($4.8 billion) deal.

Shares in Tesco, up 12 percent this year prior to the update, fell 7.8 percent by 0945 GMT, on course for the biggest one-day drop since July 2016.

"I don't think the market had fully factored in the Asian side (of the business) but we're really encouraged by the UK," Chief Financial Officer Alan Stewart told reporters.

Lewis has been steering a recovery after an accounting scandal capped a dramatic downturn in trading. He has bought Booker to reach new markets such as restaurants and improved Tesco stores, staffing and lowered its prices.

Analysts said the results showed the company was heading in the right direction with the UK and Ireland, which contribute nearly three quarters of group profit, performing well.

But challenges lie ahead.

GROWING PRESSURES

Tesco has a leading 27.4 percent share of Britain's grocery market, according to industry data, although it could be overtaken by Sainsbury's proposed 7.3 billion pound takeover of Walmart's Asda.

The tie-up between Tesco's two nearest competitors, which the regulator is probing, is driven in part by the rise of discounters Aldi and Lidl, who are gaining ground on Britain's big four grocers, as well as the growth of Amazon.

"There are any number of incremental improvements within this statement. However, it is not all plain sailing," said Richard Hunter, Head of Markets at Interactive Investor. "To maintain the market consensus of the shares as a strong buy, Tesco needs to keep a firm hand on the tiller."

In Asia second quarter like-for-like sales fell 4.8 percent, which reflects Tesco's decision to exit non-profitable cash and carry sales in Thailand. Underlying sales in the Central Europe division fell 2.0 percent, reflecting weak sales in Poland.

Lewis said Tesco was committed to both Thailand and Poland.

"In Thailand we're market leader, it's still the most profitable part of the group and there's still significant growth to be had," he said.

Tesco was suffering in Poland because of restrictions on Sunday trading.

"We've lost a number of trading days again in the quarter and that just requires us to keep constantly improving the efficiency and productivity of that business in what is quite a challenging market," said Lewis.

He said the difficulties in Thailand and Poland did not imperil Tesco's key margin target for the group to earn between 3.5 and 4 pence of operating profit for every pound customers spend by the end of its 2019-20 financial year.

Tesco was "firmly on track" to hit that target as well as cost savings of 1.5 billion pounds and the generation of 9 billion pounds of retail cash.

STRONG SUMMER

Analysts at Barclays said that was "an important reiteration given that the delivery date is only 18 months away."

They maintained their "overweight" stance but cut their full 2018-19 year operating profit forecast for Tesco by about 3 percent to 2.06 billion pounds and their forecast for the following year by 2 percent.

Tesco held its own in a strong summer for Britain's overall grocery industry which was boosted by record hot weather, a royal wedding and the soccer World Cup, delivering a 2.5 percent increase in second quarter like-for-like sales - an eleventh straight quarter of growth.

After the Booker deal it has also made further restructuring moves in the market. It has agreed to form a global purchasing alliance with France's Carrefour, while last month it launched Tesco's new discount format Jack's.

Lewis said the first two Jack's stores were "trading really well".

Laith Khalaf, senior analyst at Hargreaves Lansdown, said revenues, profits and debt were all heading in the right direction, but margins were not improving as quickly as hoped.

"The acquisition of Booker group is progressing well, and a recent buying agreement with the French supermarket group Carrefour will give Tesco extra muscle in a market where it may soon face the combined power of Sainsbury's and Asda," he said.

($1 = 0.7693 pounds)

($1 = 0.7692 pounds)

(Additional reporting by Paul Sandle; Editing by Kate Holton/Keith Weir)