It has been a tough few years for Tesco. The business that could once do no wrong stopped listening to customers, lost some of its lustre and saw its longstanding gains in market share come to an end in Britain. New management recommenced the listening process and just over a year ago announced changes to its trading strategy in its core UK market, including a re-basing of its operating margin by nearly 1%.

With this resource in tow, Tesco embarked on a programme of work focused on six priorities identified by CEO Philip Clarke. We saw evidence of this last year with new teams dedicated to improving fruit and veg availability, more checkout staff and work to improve Tesco’s private label ranges. This will take another year or two to complete. We believe Tesco is also about to commence more overt work on its near 40 million sq ft estate in the UK, with more space for food and clothing, lots of refreshment and even some downsizing.

“We believe Tesco is about to commence more work on its estate”

Such work is the outcome of running Tesco UK too hot for too long, to use Mr Clarke’s phrase. However, while this work is essential, could there be a more fundamental change taking place at Cheshunt? Is there an evolving strategy taking shape reflecting how markets continue to change with less money in folks’ pockets as wages fall behind price rises and technological advancement?

We think so. We believe Tesco will take at least one foot off the store opening treadmill. It will open fewer hypermarkets and concentrate on small supermarkets, c-stores, dark stores and other online initiatives.

In pursuing such a strategy, we believe that over time a trickle of free cashflow will build to something more substantial. Tesco will be better able to cover its dividends by cashflow, have a stronger balance sheet and consider what may be considered shareholder-friendly initiatives like lower dividend cover and maybe a share buy-back.

A business focusing on returns and cashflow to good effect may also be infectious for a sector where for many years management has been keen to spend with less regard for demonstrating capital returns. We look for Tesco’s forthcoming results to support our view.

Dr Clive Black is head of research at Shore Capital Stockbrokers

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