Tesco PLC (LON:TSCO)

H2 11/12

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Apr 18, 2012

Everyone, and thank you for coming along today. After a few presentations, two from me and two from Laurie, a little longer than would normally be the case, we will open up to Q&A, which Steve Webb is going to chair. In a minute, Laurie will take you through the main features of last year's numbers. For most of today's content, we will focus on our plans for the U.K., and on how we are tackling the other priorities for Tesco, those that I laid out a year ago at this very meeting. Since my first preliminary results announcement, I think we have acted where the strategy wasn't delivering as we would have hoped. In the U.S., we got Fresh & Easy moving towards breakeven before accelerating investment. In Japan, we announced our decision to exit after eight years. At the bank, we slowed down migration to focus on greater reliability in the future, and also in the U.K., took a significant step to correct our pricing position, and then in January, acted decisively to address the underperformance at home. I have been here a year now, and the thing about coming back to the U.K. has been it gave me a unique opportunity. Eight years is a long time in business, and that time away meant that upon my return, I could take a rather dispassionate view of the business here, at the industry, look at it from just about every angle. That led to a fundamental reappraisal of the U.K. And whilst it's not original to me, I have to say that I believe in the U.K., this industry has been running up the down escalator. Space growth is too fast. More very big stores aren't the answer any longer. Customers are moving faster to smaller stores and to the internet. Social media will soon be as influential as press advertising. And when Tesco does its best work, it does so by following the customer. That's what we are going to do. We are going to change our approach. That will mean there will be slower space growth, there will be fewer, bigger new stores. There will be more convenience. There will be more online. And crucially, there will be more personalization, and there will be more localization. Quite simply, we are going to build a better Tesco, a more modern Tesco for customers, for our colleagues, for the communities that we serve, and therefore, for our shareholders. The Tesco of the future will put more back in for customers, will get back to driving profits through sales, will make multi-channel a profitable reality, will act decisively where we see underperformance, and will strike a better balance between growth and returns for shareholders. Over to Laurie now to take you through last year's numbers. Thank you. Thank you, Phil. So good morning, everyone. I'm going to start my presentation this morning with the group headlines, followed by a brief commentary on the segmental performance. I'll then cover the balance sheet and cash flow position, including an update on the financial metrics that I set out a year ago. Group sales for the year was GBP 72 billion, up 7.4%. Group trading profit was GBP 3.8 billion, up 1.3%, and underlying profit grew by 1.6%. Group profit before tax increased by 5.3%. Underlying diluted earnings per share increased to 37.41 pence. Consistent with our policy of growing dividends broadly in line with underlying diluted EPS on a constant tax rate basis, the full-year dividend is 14.76 pence per share, up 2.1%. We've held net debt stable in the year, and we're pleased to report an increase in our return on capital employed, up 40 basis points to 13.3%. These results are in line with the revised market expectations post-January and do demonstrate the breadth of the Tesco Group. Thanks to strong performances internationally, particularly in Asia, we've been able to deliver profit growth for the group, despite a challenging year for the U.K. and the impact of PPI for the bank. In the U.K., we saw strong total sales growth driven by good new store performance. But our like-for-like growth was disappointing, particularly in the second half. This wasn't helped by reduced inflation from Big Price Drop and a weak Christmas, affected by substantial increase in competitor couponing activity. That said, for like-for-like, our like-for-like recovered somewhat post-Christmas. Net trading margins also reduced in the second half, and I'll return to this, and particularly the shape from half to 2011/12 into half one this year and of course, latter through to half two. In Asia, we delivered a good performance across all markets with solid like-for-like growth for the year. The reduction in like-for-like sales growth through the fourth quarter does reflect reduced inflation in China and Korea and the earlier timing of the Lunar New Year festival in 2012. Our performance in Thailand was obviously affected by the floods, falling from 8% like-for-like in the first half to 2% like-for-like in the second half. I'm delighted to say the country is getting back to normal and with Tesco Lotus returning to strong growth. Margins in Asia are up by over 60 basis points in the year. This is mainly due to the swift resolution of our insurance claim in Thailand, which has mitigated the profit impact of store closures. Korea and Malaysia both had a good year for sales and margin growth, although this was offset by increased losses in China. In common with other businesses, we faced a challenging year there. A resilient overall performance in Europe was impacted by two factors. The crisis tax in Hungary, which had a material effect on profits, was GBP 38 million in the year. Despite a strong performance in sales, profits in Poland were held back by significant disruption connected to the opening of our new distribution center, a non-food stock write-off near the end of the year. Excluding the impact of Hungary crisis tax, we saw a decent double-digit profit growth in Central Europe and a pleasing performance in light of the broader economic issues affecting the Eurozone. Our Irish business delivered a robust performance in the context of the severe recession there. The particular circumstances of both Ireland and Hungary have led us to focus on driving trade from existing stores, and we've scaled back our investment in new space. Focusing our efforts on stores we've got has driven a strengthening like-for-like and the continued increase in market share in both markets. Moving on to the U.S., Fresh & Easy has delivered another strong top-line performance and we've reduced losses by nearly 18% year-on-year. This is the first full-year reduction in losses since entry. An increasing number of stores are now reaching shop door profitability, and more will reach that point over the coming months. This chart on EBITDA, which is a good proxy for positive cash flow, shows it. The red dotted line in the middle represents the points where stores have cost into positive EBITDA. In addition to the 30 stores on the right of the line that are already making positive cash, the two bars to the left of the line represent 118 stores and shows that a large number of stores are very close to crossing the line. Nearly half these stores are within $5,000 per week of being in positive territory. That's a much more encouraging picture. Tesco Bank increased its baseline profitability. That is profit before all key provisioning, very strongly. It's up by 29% to GBP 203 million. Excuse me. Fair value releases reduced significantly from GBP 155 million to GBP 22 million in the year, and going forward, these will be immaterial. Trading profit for the bank was GBP 168 million, which is after the GBP 57 million charge of PPI we announced at the half year. Our net provision for PPI stands at GBP 75 million, which puts us in an appropriate position based on our claims experience to date. Our decision to slow down the final stages of migration resulted in a hit to profit of around GBP 40 million, which will now begin to reverse. The bank's overall capital position improved again, with the risk asset ratio improving by 240 basis points to 16%. The liquidity of the bank has also improved the retail bonds issue, giving us greater diversity, and helping the bank's funding position. As announced at the half year, we have treated Japan as discontinued. This results in a total charge for the year of GBP 142 million below the after-tax line, which includes a small trading loss of GBP 25 million, which is similar to last year. I'm pleased to say that the divestment process is nearing completion, and we'll update you as and when appropriate. Turning now to the balance sheet, net debt remained stable for the year at GBP 6.8 billion. This is a little behind our guidance we gave at the half year, and that's due to, firstly, the impact of Christmas, our trading results on cash flow, and a lower working capital inflow linked to the higher stock levels than we planned. Group capital expenditure was slightly below the half-year guidance at GBP 3.8 billion due to tight control of spending. Operating cash flow from retail operations is down slightly year-on-year to GBP 3.8 billion. Again, this is wholly due to the working capital inflow. Our strategy to release value from the property portfolio has had another successful year, generating GBP 376 million of property profits from about GBP 1 billion worth of disposals. The launch of our first property fund in Asia completed successfully after the year end, raising GBP 379 million from 70 mature malls in Thailand. We saw exceptionally strong demand with the fund pricing at the top end of the range and being 11 times oversubscribed. Since launch, it has been trading 10% ahead of its listing price, a strong indication of overall value of our operations in Thailand and, of course, elsewhere in Asia. Finally, on the balance sheet, our IAS 19 pension deficit has increased to GBP 1.4 billion, largely as a consequence of the reduced corporate bond yields and generally lower market returns. We announced changes to the terms of our defined benefit scheme last month in order to make it more sustainable over the long term. We have also made a one-off cash contribution of GBP 180 million to the scheme after the year end. This is anticipation of the forthcoming outcome of the triennial actuarial valuation, which we believe gives a more accurate indication of the likely costs of future funding of the scheme. One year ago, I set out four key financial metrics which I said I would update you on at these meetings. Starting with the top left of the slide, we improved our return on capital employed from 12.9% to 13.3%. This improvement benefits obviously from Japan now being classified as discontinued. We held fixed charge cover and net indebtedness broadly flat. Both measures will, of course, be directly affected by the U.K. investment plan we have announced in 2012-13. As you will remember, our target for fixed charge cover is between four and four and a half times, with a ratio of two and a half times to lease adjusted net debt to EBITDA. Finally, I have already mentioned that we came in slightly under the guidance on capital expenditure of 5.3% of sales, and that is right in the middle of the 5%-5.5% range I laid out last year. I will now hand over to Phil to give you an update on the year and our plans for the U.K. business. Thank you. Thanks, Laurie. I am going to begin with a candid assessment of the business as I see it, and then focus on our plans for reinvigorating the U.K. It has been a tough year. Although the international businesses performed strongly, delivering an 18% rise in profits, that just compensated for the reduction in the U.K., leaving overall group profits only slightly up. That means that despite some really good things going on in Tesco, last year was not one we could really be proud of. You know the background. In a difficult environment for consumers at home, we have chosen to face into the need to improving the shopping trip for our customers and tackle, with increasing urgency, some longstanding issues. Those decisions have clearly had important financial consequences for the year we are reporting today, for the year ahead, and, of course, for our shareholders. Deciding to give up some short-term profit to safeguard the long-term health of the business was a very difficult call, but I strongly believe it was necessary. Having looked at the business hard since last summer, and in particular, in the light of a disappointing Christmas, I felt the pace of change needed to accelerate to get Tesco U.K. back where we want to see it: leading, performing, and growing again. I said a year ago that I had inherited a great business built around customers and staff with high-quality assets around the world and multiple opportunities for growth. I still strongly believe that. But what's clearer to me now than it was then is exactly how much we can do with the right plan in the U.K. The recession hit Tesco hard, and it was longer and it was deeper than we'd anticipated. We did well to maintain our growth through most of it, but with the result that too heavy a load was placed on the U.K. to support the group. We had to confront this uncomfortable truth, and that's really the background to the decisive action that we have taken in the last few months. There was a need for change. Many of you saw it, and now we're driving it, and we're also, as you've seen, renewing the management team in key areas to deliver it. It has three aspects. First, we had to start putting more back into the business than we were taking, and I'll come back to the U.K. in a minute. Second, we couldn't just wait for economic recovery. We had to reduce the drag and risk to our growth by taking action on other areas of the business that were holding back our performance, such as the U.S., Japan, and the bank. I think we can point to tangible evidence of progress in each of these areas. And third, and at the same time, we had to increase our focus on the long-term strategic objective. That's ensuring the business remains well-positioned for the opportunities and for the challenges of the internet. This is important because we recognize that issues facing retailers today are not just cyclical, they're structural. We've already put more resources behind this, and the pace of change has noticeably quickened in both food and in non-food. And that means it is right to take a different approach to allocating capital, a new approach that fits the future. Again, I'll come back to that shortly. These actions are why the priorities I set out for my team last April are every bit as relevant now as they were then. As a reminder, they're shown on this slide. These are our immediate management objectives, the things we're very focused on. I'll touch on each of these in my presentation, starting with international, but I'll spend the majority of my time on the U.K. Internationally, we had a good year. That 18% profit growth I mentioned would have been 22% without the impact of the Hungary crisis tax. I'm pleased with that performance because in several of our large markets, like Ireland and Hungary, economic conditions remained very challenging. There are many good things to talk about with the international businesses. U.S. losses started to fall, and I have more confidence now that we'll look back and say, "This was more than a turning point for losses. It was a turning point for Fresh & Easy. Of course, there's a lot more to do, and I'm quite sure some will say it would have been better if the reduction in losses had been greater. While sales growth remained strong in the second half, the reductions in costs that we'd achieved in the first half didn't continue at the same rate in the second. I don't think anyone can argue this isn't a decisive change of trend after four years of rising deficits. The simple truth of it is that we're all proud of Fresh & Easy and what it delivers for customers today. The stores look good. They're getting better all the time, so it's no accident that the 2-year like for like is running at over 20%. Of course, we also want to be proud of what it delivers for our shareholders. We did plan to get to 300 stores. That's what we need to cover our overheads. Because I want to see more existing stores cross over into profitability before we push on, I think it's right to be more measured on new capital for the time being. This means we should be at or around break even by the end of 2012/2013, before overheads, but after distribution and campus costs. When we get close to that, when we've proved that, we'll pick up the pace of new space. Another strong feature of the international performance was market share growth. You can see from this table how we've performed this year in our markets in Asia and in Europe. These numbers represent, in the main, good progress, continuing the improvement which we've sustained for more than a couple of years now. Our business in Thailand has had an extraordinary year by any standards. The flooding catastrophe which engulfed the country didn't do lasting damage to Tesco Lotus. Instead, they came out stronger. At the worst, we had over 150 of our stores, mostly Express, closed and all four depots underwater. I don't know how you feel about it, but I love this picture. I've never seen anything like it in my years in the business. Despite challenges like this, we kept our like for likes and our profits growing, although the latter was helped thankfully by having adequate insurance cover. I was also pleased with the further growth and success of our multi-format strategy. This chart shows how diverse our international space has now become. 20% of our space today is in compacts, in supermarkets, and in convenience stores. The new growth, though, is increasingly in these smaller formats, 49% in this year's program, as you can see from the chart. This is true across international, with the exception of Turkey and China, where hypers are still less developed. Despite what appears to be a widespread misconception, we're not calling time on the hypermarket. The success of the Extra program internationally demonstrates there's a lot more to come from these stores. The cumulative improvement in sales in the 31 conversions in Europe and the three in Asia that we've completed so far is 17%. The future of the hyper may well be smaller. It may be food and service-focused, with a tight general merchandise assortment and a strong clothing offer. But in that slimmed down form, I believe there's plenty of life and growth in it yet. There were two markets in international where performance wasn't so good. First, as Laurie has explained, we had a distribution center issue in Poland in the second half. It put a dent in Europe's second half performance after an excellent first half, as you will all have seen. It is behind us now. Second, things got tougher in China. We are not immune from the slowing economy, from the impact of high inflation and even higher wage costs. You can see it in industry like for likes, and that has led us to take a more cautious stance on the market, at least for now. We have decided to hold back on an increased hyper development program for the time being. We will open only 16 stores this year instead of stepping up as we had planned. We still believe that China can be an engine of growth, but are constrained by these short-term challenges. It is a similar approach to that I have taken in the U.S.A. Slow down, rebuild, then accelerate. Finally, on international, whilst Homeplus had another great year, the changing regulatory environment in Korea towards large retailers looks like being unhelpful. We have not yet seen how the new restrictions on trading hours, they limit 24-hour trading and require large retailers to reduce the number of trading days by between one and two a month. We do not know how they will be implemented across the country, but our current view is it will have the effect of reducing like for likes modestly in the year ahead. Closing on international, that we could weather these challenges and still achieve an 18% growth in trading profit to GBP 1.1 billion is really pleasing. That is more profit than any of our domestic peers and a reflection of the quality of the business we have created in less than two decades. Before I turn to U.K. retail, a few words on the bank. Tesco Bank is a major part of our strategy, but I completely understand why people have been frustrated with the timelines. However, I am pleased to say that the three-and-a-half year project is almost complete. Because we have taken great care to get it right, we now have a great platform, a low cost model, robust modern systems, good market positions, and with 75% of the business already conducted online, enormous potential for the future for financial services at Tesco. The next large new product will appear soon after migration, starting with mortgages. As we put more than three years of transition behind us, the bank is well-placed to deliver good growth starting this year. I am going to move on now to the main topic of today, to the U.K. I spoke earlier about the background to the decision that we have taken. You know how it has been. Take a look at these charts, which illustrate some of the causes. The first shows, during a period of recession and prolonged strain on consumers, how we continued to drive profit growth ahead of sales. Until 11/12 margins, that is the light blue line, were gently rising. This was despite slowing like-for-like sales, that is the red line, and the burden of incremental costs. We did not miss a beat, but that meant we put a strain on the business. A consequence of this was that, as this next chart shows, the productivity hours of the stores was too great. This chart looks at our productivity index, we use the term PI, an expression of the hours stores are allocated relative to the very precisely measured tasks they have to do. I said we have been running the stores too hot, and this index, running well over 100 for a sustained period, is what I mean by that. The effect in the stores is that some colleagues are working too hard. Staff are being pulled around the departments too much and do not have time to look after their areas. Above all, our standards are not as consistent as we would like. We simply have not given our staff what they need to look after customers as well as they want. It was not that we were or that we are delivering a bad shopping trip for millions of customers every week. That is not it. At the core of it is that the key elements of the shopping trip, the things which influence where customers shop and how much they spend, stopped improving in the small, the incremental ways they have done for a decade. The truth is, in retailing, every little helps. Those small improvements are often subtle. They are as much about reliability and consistency from one trip to the next as they are about new and different things. But actually, they are the lifeblood of like-for-like growth in the industry. There were other components, of course. Non-food was more of a problem for us than for others, especially as we had had our big surge in new space for non-food much earlier in the last decade. At the heart of it, though, I believe, is that we are simply taking more out than we are putting in, and that is not sustainable. It was not that the business was blind to these issues either, but we expected the tide of economic recovery to lift us, and frankly, it did not arrive. The shopping trip is not broken, and I think this important next chart illustrates why. See, even when we were at the top of our game in 2002, we never were seen to be the best at everything in respect to these key aspects of the shopping trip. Winning in the industry is having the right blend of performance on these measures and, as I said before, getting back to making steady incremental improvements by putting more in for customers. I think you can see the influence of staffing here. It is all too clear, and that is why it is our first priority. If they are working too hard, they are just not as helpful. That is behind what we did in January. We know what is wrong and importantly, we know how to fix it. Whereas we thought we should fix it over three years and have developed a plan to do so, I came to the view in January it was vital to face it with dealing it now and get on with it. Addressing the staffing issue is the biggest single component, and this is where we have decided to do three years' work in one. What we found in the trial stores is that customer perception of all aspects of the shopping trip gets better if we sort out the hours, if we train our people. The GBP 1 billion investment plan to Build a Better Tesco is underway. On to the plan to Build a Better Tesco. It has got six elements. Firstly, helping our people deliver great service. Secondly, making our stores better places to shop and to work in. Thirdly, delivering great value for money. Fourthly, building the right ranges of quality products. Fifthly, making sure that we get back to having the right conversation with our customers. Finally, making clicks and bricks a potent combination for customers. We are making a significant investment in each of these areas, and it is the coming together of them that will build a better Tesco for our customers. I will just take each of them in turn quickly now. First, staff and service. Putting the staffing levels back in and training the staff in key departments, particularly in the fresh areas and in the bigger stores. We are recruiting, we are training, and we are equipping 8,000 staff right now, and many of them are already in the stores. This activity alone will require revenue cost investments of over GBP 200 million. It will bring PI back to the index of 100 in the key areas. This is the three years' work in one that some of you have heard me talk about. All of the extra staff are dedicated to particular departments. In the first wave, that is produce, that is meat, it is chilled convenience, it is beers, it is wines, and it is spirits. In the 200 pilot stores where we made these changes already, we are seeing encouraging results against control stores, and you can see them on this slide. It is very encouraging. First, our mystery shopping scores have improved. Second, while sales in the newly invested departments improved, the overall store sales increased, too. In the initial 16-store trial, which began last summer, like-for-like has improved by 1.2%. In the more recent 200-store extension, after 17 weeks, like-for-likes are 1.1 points better so far. These results are very clear. The same changes are now being extended to all Extras and all superstores, and will be live in just four weeks' time. The second element is stores and formats. There is a lot to talk about here, but the essence of it is we are going to love the stores we have got, and the overall pace of new development will moderate. The pace of refreshing stores has already stepped up, and we aim to complete all the large stores by the end of 2013. We will do 430 stores this year to improve the look and the feel using warmer colors and materials, better lighting, improved sight lines across the store, and as you see here, less functional signage. It does not involve high levels of capital per store because the stores generally are well invested, but it does make them look less clinical, less industrial. As you can see here, there is again an emphasis on key departments like counters, like fresh foods, and bakeries. 40% of Clubcard holders will notice the difference this year alone. Some of you know I like to get into the detail, and having examined every aspect of what we have in terms of space and what is right for the future, we are taking a fundamentally different approach. Putting down a lot of new space has produced great results for Tesco in the past. I do not think the current race for space across the industry is the key to a sustainable future. On development, there will be less new space overall. 1.5 million square feet this year, nearly 40% less net new space than last year. Our new space will also reflect the growing importance of our online business in general merchandise and our desire to focus on the most productive use of new capital. We will expand in all formats, but we will prioritize expanding Express at least as fast as we are now. It already looks after a third of our customers. We will invest more, as I have said, in dot-com-only stores. We will build out space where we are committed to complete. On hypers, we will still be doing them. As I said earlier, they will be smaller. Food, services, and clothing focused, and that makes sense given the rapid growth we are seeing in non-food online. Just before the epitaph of the hyper is written, let me say, in the U.K., we have just 10 stores over 100,000 sq ft, and only 52 stores over 80,000 sq ft. The vast majority of our 750 or so large stores remain very profitable, very popular stores. Take a trip to Slough or Kingston Park or Sandhurst or Corstorphine if you need a reminder. Strategically, this is much more about how we anticipate the influence of the internet in the future than it is about dealing with the surplus of space today. It is much more about saying what we want Tesco to be in the U.K. in 2020 than saying where it is now is wrong. Price and value is the third, being best all-round value for money. We made big changes to our price list with the Big Price Drop last September. It got off to a good start, but it wasn't sustained because we lost the marketing battle at Christmas. We are now more competitive. That's an important step on the journey, but there's more to do to get the blend right on price, promotions, on couponing, and on loyalty. We didn't get that blend right over Christmas, but we've been doing a better job since then. As it's a very commercially sensitive area, I'm sure you'll understand if I don't give you chapter and verse on our plans. Our customers are going to see more change, and they're going to see it soon. Fourth, range and quality. We're picking up the pace on ranging, starting with a complete relaunch of all the Tesco brands. Again, it's not broken, but it does need a refresh. Better quality, better packaging, more innovation. This will touch over 8,000 products and 40% of our sales in the next 24 months. We've already started the work, beginning with Tesco Value. Even before we relaunch it's growing at over 10% because more customers use it to make tight budgets go that bit further. As you can see from the new packaging, Everyday Value is a big improvement. Over 200 of the products have been reformulated using higher-quality ingredients. They've all been benchmarked and passed against their equivalent. We're also starting to use the capability we've already developed, deployed with success in Express to make our ranging more store and more format specific. I think there's a big opportunity here. Of course, Tesco will always have broad appeal, but having the same range in Alfreton and Amersham isn't doing all we can for the different needs of customers in those stores. That's changing, too. There will be more personalization. There will be more localization. This is where dunnhumby is playing a very important role. We've brought them right back where they belong, to the heart of the business. They help us by taking insight from Clubcard to make the customer experience at Tesco more personal, more relevant. This is a very substantial project for the U.K. in the years ahead. Fifth, brand and marketing. We've already made changes in marketing. I'm pleased to say that Tim Mason is heavily involved in the work. Only last week, we began our creative agency review, the first in well over a decade. Quite simply, we need a different conversation. Finally, part six. Making clicks and bricks a compelling combination for customers is how I see Tesco remaining one of the long-term winners. It's a key part of the Building a Better Tesco plan because of that. Sure, we have to fix some things in the U.K. business right now, but we must also keep a clear focus on the strategic opportunity of the internet for a business with our scale, with our reach, and with our capabilities. By 2020, every person under the age of 21 on the planet will have been born in the digital age. It's already changing the way people live their lives and the way that they shop. Right now, I, you, could order a non-food item on your smartphone from Tesco Direct and have it delivered tomorrow by 3:00 in the afternoon to a local Express store for no charge. I believe we're very well-placed to prosper in the digital age. Food was first. We're making money. We have a model no one can match in our international markets. I'd rather be coming at this from a strong base in food than from anywhere else. The challenge for everyone, of course, is making money in non-food online. In total, our online businesses grew sales last year to over GBP 2.8 billion and increased their profits despite a strong development cost headwind. In the U.K., the online businesses are doing very well. It's not bad, really, if you think our 47% market share at Tesco is still growing. Tesco Direct is also going through a big step change in our offer right now. Starting with grocery, sales grew 13% and profits increased. Extra investments in the business, adding capacity, delivery slots, more flexibility on delivery charges, including a monthly fee for multiple orders, were well received where we offered them to customers. They also really like food Click + Collect. It's now in 45 stores and adding to our growth rate. With the opening of Enfield dot-com only store, we've almost completed our London network, enabling much more range to be offered across the very diverse London market and giving many of our large, high-density stores a bit more room to grow. The last two London-focused dot-com only stores will open before the end of 2013, and this model will then be applied more widely, with stores penciled in for Oxfordshire and the West Midlands after London is complete. Obviously, this isn't all about the U.K., either. Developing the operating model once and applying it everywhere is a great example of our applying group skill and group scale. Internationally, in Ireland and Korea, the operations are doing well. In Korea, the business is already the size of more than two of our largest hypermarkets, and it doubled its profitability in the second half, helped by the development of the innovative mobile apps and the now famous virtual stores in subways. We made a strong start in Prague with sales ahead of plan and the start's not far off in Warsaw. I don't have to tell you, that's a different approach to capital productivity. In non-food, Tesco Direct has begun launching its new online platform, delivering much more content for customers. A new website with much more functionality. A doubling of the range planned this year from 40,000 at the beginning of the year, 80,000 now, to 200,000 by Christmas. Thanks to Marketplace, where third-party vendors can sell through tesco.com. That began the first stage of its phased launch just three weeks ago. Click + Collect in non-food is now in approaching 800 stores. It takes 70% of our non-food online volume. The 70 Expresses we put in it are doing very well. Because this is one key area where we're developing a competitive edge, we'll have 700 Expresses offering this by the year-end. 700. Few people are more than 10 minutes from a Tesco in the U.K. That ubiquity, that convenience for millions of customers should be a big advantage for Tesco. There's a lot to do here, but we're already very profitable online. We have a uniquely strong global supply chain and an unrivaled store network that can give us compelling advantage in fulfillment for customers. So that's why we're pushing on fast with our clicks and bricks strategy. So that's the essence of the Building a Better Tesco plan. Clearly, we expect each element of it to contribute to an improvement in like-for-like sales. We'll do a lot in year one, but some elements will take a bit longer. I've got the team I want to drive through this plan. Here they are. Many of you know them from our international investor trips to Europe and Asia. Every one of them has worked in at least one of our overseas businesses in the last five years. They've brought back new ideas, new energy, and bags of experience. In summary, on the U.K., we know what the issues are. We know how to fix them, and our early work gives us encouragement. So we're getting on with it, and good execution is, of course, now essential. That's why I'm applying more of my time to it, and I know that's not ideal. But because getting the U.K. back to form is so important to our shareholders, so important to the business, it has to take priority right now. With a good handpicked team, we're confident we can get the business back where we all want it, leading, performing, and growing. Those are my definitions of success, but it starts with doing a better and more consistent job for customers week in, week out. If we do that, they'll reward us with sales growth again. It'll take a bit of time. We're very confident we'll get there. I'm now going to hand back to Laurie. He'll take you through the financial consequences of the U.K. reset, the changes to our capital plans, and the outlook for returns and for cash generation. Laurie? Thank you, Phil. As Phil said, I will take you through the financial implications of the U.K. plan, before describing the financial strategy, which supports the changes that Phil has described in terms of CapEx, space, returns, and cash. First, on the plan. We are comfortable with the guidance we gave in January, has been appropriately reflected in the range of market forecasts for both the U.K. and the group. For the avoidance of doubt, these forecasts show an average trading margin for the U.K. of around 5.2% for the years 2012-13. The shape of margin progression from the second half of 2011-12 through 2012-13 merits explanation, particularly as we expect the level of margin to be broadly flat in 2012-13. That is between half one and half two. The second half margin of last year was down 60 basis points year on year. That was driven by three factors. The GBP 500 million investment we announced in September was, and we said at the time, part funded by Clubcard, but just over one-third of it was new money. There was an initial overlap between Big Price Drop and double Clubcard. Thirdly, we took a significant hit to margin for non-food stock and clearing it at the end of the year. These issues were partly offset by a reduction in the accrual we had built up for short and long-term bonuses. The level of which, of course, changes in line with the performance of the business. The issues I have mentioned do not repeat in the first half of 2012-13. The balance of Big Price Drop is now fully funded through the realignment of promotions and supplier funding. There is no double running of Clubcard. The obsolete stock has now been cleared or provided for and new and better ranges are arriving. The margins in the first half of this year are expected to be down year on year, and this is wholly due to different reasons. The main drivers are the staff and refresh investment effects. These effects do, of course, continue in the second half, resulting in a broadly flat shape for the whole year. The financial strategy which supports Phil's plans, as laid out, is one of increased capital, discipline, and restraint. As a result of our future plans, included is a reduced level of group capital. It is down to GBP 3.3 billion in 2012-13, and beyond that, comfortably less than 5%. This is just not making a virtue out of necessity. We have moved into a new phase of growth for the group. Beyond the diversification and expansion phase, where gaining critical scale and exploring new opportunities were the prime objectives. Today, all of our businesses compete for capital on the basis of balance of growth and returns for each investment in what they can deliver. More importantly, though, the new plan and the shape of our growth leads to further significant changes. Across the group, more of our capital is growing into smaller, higher returning formats. We will be investing less overall capital in our U.K. business, driven by a 38% reduction in net new space. We will be opening many more stores in the U.K., but they will be smaller and more focused on food than non-food. The lower capital expenditure also absorbs the GBP 200 million in large refresh program, in addition to an increase in our online investment of around GBP 150 million. We've already embarked on some of this work in the U.K., and it's bearing fruit already. Higher returns on new space that we've opened are showing that. The stores included in the 2010-2011 opening program are ahead of target. I'm pleased to say they are already delivering in excess of a 10% CROI, even though most of them are open for less than two years. The level of capital work in progress in the U.K. balance sheet now stands at GBP 2 billion, as a consequence of the front loading of our investment in our pipeline near the end of the last decade. Burning off this pipeline, principally by building out stores faster than we put new sites in, will be a key contributor to the U.K. space growth over the next few years. The completion of mixed-use schemes within WIP balance will play a significant role in bringing down to a more appropriate level, although the construction phase on these schemes will add to the balance in 2012-2013, and then a rapid reduction thereafter. In some instances, we may also dispose of standalone sites that do not meet our new, more rigorous returns hurdles. What does that mean in terms of cash outlook for Tesco? With an overall reduction in group capital expenditure, a return to growth in cash contribution from the U.K. business, the international business is making an increasingly positive contribution, and a return to strong working capital inflows, the outlook is increasingly cash generative. To scale this for you, in 2011-2012, we held net debt broadly flat, supported by the release of GBP 1 billion worth of proceeds from our property transactions. In the next few years, our internal plans move as quickly to a position where these proceeds at first create and then form just part of a significant positive cash inflow. Of course, capital restraint and improved cash generation by definition result in improving return on capital employed. When we laid out our commitment last April to improve ROCE to 14.6% by 2014-2015, we showed you this chart, highlighting the current levels of returns across various cohorts and describing some of the levers we would use to drive overall group number forward. In the short term, our investment plans in the U.K. make achieving this target more challenging. Indeed, it's likely that we'll see a small reduction in 2012-2013 as a result. However, we described last year a number of significant opportunities to increase returns, such as driving growth in the bank, benefiting from the regional scale in Central Europe, and moving the U.S. to profitability, in addition to the structural benefit of our maturing international business. As such, we didn't need all of the parts of the plan to come off to reach the target. These opportunities still exist. Indeed, our decision to divest the Japanese business has already made a contribution. It is true that we now have fewer options by which to deliver the targeted improvement, but we are helped by a much smaller drag from our new capital over the next three years, for the reasons I've already outlined. To conclude, the financial strategy I've described is one of capital discipline and restraint. It supports a more sustainable level of growth, a growth that focuses us on getting more out of the businesses that we currently have. It benefits from a less capital-intensive form of investment, less new space, more focus on existing stores, more new small stores, and more into online. It reduces non-productive capital and applies higher hurdle rates to new opportunities. In turn, this drives higher returns and a higher level of cash generation. The plans that Philip has outlined clearly make Tesco better for customers. I believe the financial strategy supports those plans and will make Tesco better for shareholders. Thank you. I'll now hand back to Phil. Just a few words to close before we invite questions. I think in the end, it all boils down to this. First and foremost, this is a great business with a special place as the U.K.'s biggest retail company. The results we've announced today show record group profits. Whilst there's lots of work to do in the U.K., I'm incredibly confident that together, this team can get the business back to where we want it to be. How will we do that? Put simply, by doing what Tesco has always done best, innovating, changing, adapting, developing to meet our customers' needs. Now we have to show leadership in a new era of retailing. In the 12 months that I've been in this job, I've looked at every aspect of this company, and I mean everything. No part of the business is bigger than the Tesco brand. The conclusion I've come to after all this looking and all this listening is quite simple. I'm not interested in finding new places to plant more flags. We don't need to chase the future. We need to focus on what we have. That's what today's plan is all about. This is about making sure every part of the business is successful, is strong, and is growing. It's about making the right calls about margins and services and space. Above all, it means giving the customer value for money. It means putting the customer first. It's a plan for a better Tesco, better for customers, better for our colleagues, better for the communities we serve, and ultimately, better for shareholders. Of course, these changes won't all be easy. It's a tough ask, and it's going to take a huge concerted team effort to get where we want to be. But if we get this right and make it happen in the next 12 months, then we will build a better Tesco, a better Tesco for today and a better Tesco for tomorrow. Thank you for your patience. It took about an hour. We've now got an hour for questions, and I'll hand over to the master of ceremonies, Mr. Webb, who'll lead that process. Over to you, Steve. Thank you, Phil. We will conduct it in the normal manner. If you can raise your hand if you want to ask a question. The microphones are in the back of the seats. Before we do so, I should acknowledge a debt to Mr. Darren Shirley for the Thailand photo. He knows me well enough to know that the check is not in the post. Who wants to ask the first question? Sreedhar. The microphone is in the back of the seat, Sreedhar. Oh, sorry. Typical analyst. Something for the U.K., like for likes and that you see. You need to press the button, I think. I can say no if he wants. Now, U.K. like for like, you talked about 1.2% improvement over the control estate. Are you able to tell us what are the actual like for likes of these stores and a bit more in terms of, are you happy with it? Is that in line with your expectations, or are you disappointed? Also, what level of like for likes you need to see for you to recover the additional investment in the stores? That's the first question, please. Secondly, you also talk about consensus margins, actually understanding the message in the U.K. reset for 2012/2013. Is it also your view that consensus is actually getting it right with a small margin improvement in 2013/2014, a year out? Finally, in terms of the U.K. delivering results, in the release, you talk about delivering results in the next few months. So should we actually be starting to expect Tesco like for likes starting to come in line with industry level growth? What is your timeline, basically? That's it. Thanks. Thanks, Sridhar. On the first one, I think, Phil, you should answer that one. On the second one, that's naturally Laurie. On the third one, I think we can probably all have a go at that. I think I should say, before we start getting into lots of questions about timing, that we will not be drawn on timing. So I understand why you would ask that question. It's a perfectly reasonable question to ask, but we're not going to get ourselves pinned down this morning on the timing of overall like for like improvement. Although, of course, what we're doing with the business is intended to improve like for like performance. Phil. My first phone call this morning was with Reuters, and I said, "Can we have the first question?" I do not know if you were listening, but they asked three questions, just as you did. On like for like, I think it is a good start. I think the 16 stores gave us confidence. We did 200. We started them only 17 weeks ago. They are already above 1%. But there is more to come. And what we can see is steadily these stores build. As you said, Steve, we are not going to give any false precision right now. It is very early days. We, of course, do not need to get it to cover the cost because we have reset our margins because we are reflecting that what we need to do is make the shopping trip better for customers, make all those other changes you see in the plan, and then we should see an improvement in our relative performance in the market, and that is what we are aiming for. But first and foremost, customers will tell us, and the store performance will follow. On margins. Yeah. Profit growth is much more orientated towards sales growth than margin growth. So there may be an opportunity to improve margin in the future, but it will not be an end in itself. It will be as a result of the virtuous circle getting back working in Tesco with strong volume growth, being able to be invested into improving the shopping trip again. And ultimately, if that does mean that margins can improve, they will improve, but not by a lot, I do not think. Okay. James? Do we do the third one? Yes. Good morning. It's James Grzinic from Jefferies. I wonder whether you can talk a little bit beyond current year on CapEx and space in the U.K. You seem to suggest that it'll be a further step down in 2013/2014. Is that a right reading of the situation? Can you perhaps tell us out of the GBP 3.3 billion, how much is U.K.? Do you have another GBP 200 million going to refurbs next year, I presume, and then that drops off. Can you help us with those mechanics, please? Phil, do you want to start that and pass it over to Laurie on the CapEx? The first question was, of the GBP 3.3 billion, how much of it is going into the U.K.? Was that the first question? Yeah. The CapEx for the current year that we are in is about GBP 1.3 billion, and that absorbs the increase in the internet investment, which is GBP 150 million. As you said, the refresh program, GBP 200 million. That will be the new base, and as you say, we will be refreshing in 13/14 as well. What was the rest of the question? I do not know. I presume you seem to intimate, I mean, the mixed-use schemes, for instance, are going to be reduced and perhaps in some cases even sold off after this year. Presumably, that means that CapEx and new space addition in the U.K. reduces further from next year, from 13/14. We have not made any decisions to sell anything off, James. It is simply an option. I think in terms of the new space going forward, I think, Phil, you should deal with that one, you? Yeah. 2.4 million last year, 1.5 million this year. We are starting at a new level. That is about where one should be expecting it in the future. But we have got some mixed-use schemes that we are beginning to build out. For instance, Monday, we begin demolishing Gateshead, by which I mean most of the town center. Okay. Get Carter will never be the same, by the way, for those of you who remember. We are going to build a 100,000 sq ft store there with a shopping center, with some mixed-use residential, and we will do that over 18 months. It is going to open probably the beginning of 2014. So there is that still to come. But in terms of where we are starting now, we are saying GBP 3.3 billion is where we start. It is not going to be GBP 4 billion next year. It will be GBP 3.3 billion. We do want to put more into the stores that we have. We want to love them a bit more. We think they have got to keep on refreshing. 1.5 million sq ft feels about right, but more convenience and always more online, more dot-com only stores, more in creating digital capabilities. Great thing about those is the way we build them. We build them once and we deploy them many times. So the systems and the processes that we use in Prague and that we use in Korea are the processes that we build in Bangalore, and that we use here in the U.K. So we create group assets, which is good because we can use them in more places. Philip? Sorry, got a shock there. Philip Dorgan of Panmure. Playing devil's advocate for a moment, if I may. If you look at the performance in the U.K. over the last four or five years, the increase in turnover is roughly what you spent on capital expenditure. So clearly something has gone wrong over the last four or five years, not just the recession. So, are you investing enough? Is half a million pound a store enough? You invested GBP 500 million in price last year, and your sales went down. Is the amount you are investing in price this year enough to really fundamentally reverse the business' performance? Product offer, you have got obviously that Everyday Value range looks promising, but there needs to be a lot more than that. So surely you need to be investing more. The question really at the bottom of it is really the hit to this year enough and aren't we really going to see another hit next year as you realize you haven't done enough? Secondly, the U.S., what has to happen for you to close or dispose of it? It's not hitting its profit targets. Why don't you just come out and say you're keeping it forever and draw a line under it? Because that seems to be the indication of what's happening. Thank you, Philip. Did you run out of paper? I did. I think they're for you, Phil. They're for me? Yes. Thanks a lot. Well, this Building a Better Tesco plan has been thought through for about nine months. All the things that you said that we need to do better at, we're planning to do better at. It all starts with putting more staff in the stores so that we get the products on the shelf in the right way, in the right quality, at the right time. You saw what happened to the like for likes of those stores where we did it. That's a good start. You're absolutely right. We've got to build better brands. Everyday Value, we didn't just dream that one up last week, Philip. We've been working on that one for about six months. The new formulations and new packaging for the Tesco brand aren't just things that we might do. They're things that we are doing right now. You'll see them coming through in 2012. The Venture brands are building. We've now got more than 12. We had none two years ago. They're doing very nicely, thank you. The investment in the online. In fact, the whole of the plan is designed and costed to get us back to where we want to be. We're comfortable with the way people are steering the consensus. It'll all be shown in time whether it is enough or it isn't, but we feel that it is enough. Or else we wouldn't be here today with the enthusiasm that we have got about it all. This isn't a plan that we're going to start tomorrow. This is a plan that we started last year. I suppose the one thing that hangs out there is, well, what are they going to do on price? If you look at the chart that we showed, the chart on value for money, it actually talks about more than just price. It talks about the right level of couponing. It talks about the right amount of investment in loyalty. Because these are very important things in the mix. It's about value for money. On America, I can quite understand why you want me to say that which you say I should. I listen to investors, and I understand their frustrations with us if they are frustrated. It's quite a unique business, this. In just four years, it's getting more stores across the line to profitability. So I could run ahead and do 100, and maybe we'd get there. Or I could just do half that number and get more stores across the line and convince myself and then convince the investors that here's value for the future. That is why I will not say we are staying, and I will not say we are going. What I will say is we are absolutely focused on delivering shop door profitability. It would have been great if I was standing here reaffirming that which we said 18 months ago, and you all know I am not. But the reason I can do it with a little bit more confidence, and unapologetically, is where we made changes, customers reacted. We have got more stores making profit. There is such an opportunity. I do not want to say we are there forever. I do not want to say we are going tomorrow because I do not think we are there yet. But we will get there in the next year or two, and we will have a business I confidently expect which people will say it was worth staying with. Next question. Al. Is there a microphone somewhere? It's right in front of you. Press the button as well. I have two questions. First question is on international space growth, because I noticed that in square footage terms, the reduction of international space growth in the year ahead will be greater than in the U.K. So how much CapEx saving is being made in international relative to the U.K. in the year ahead? That's the first question. And the second question, again, is on Fresh & Easy. We're at 4 or 5 years in or whatever, and -24% margin. Can you explain what the overhead cost actually is? Because you disclose the depreciation cost, I think 6, 7% of sales or whatever, but what are the costs at the center which are causing these margins? I think those are two for you, Laurie. The international space growth. Europe is basically down similar to the U.K. in terms of reduction. Of course, we've said that most of the big hypermarket expansion, probably with the exception of Turkey, is pretty much done. A lot of what we're doing now is in filling with lots of smaller stores. In Asia, less so. The reduction's about 20%. We've pulled back China, going much more carefully in China, a little bit of capital discipline and restraint in there. Thailand, within that, still growing at a similar pace. Korea, still growing at a similar pace. Pullback in Malaysia, not really by our doing. It's just much more difficult to get planning permission for big hypermarkets in Malaysia now. The U.S. is actually increasing its space year on year. The second, what's in the overhead? All the things that you would expect. The IT, the central office, the support teams that run the stores, some of the overhead that runs the campus and the distribution center. It is management. It is as you'd normally describe admin expenses. Just in terms of GBP million, what's the reduction of CapEx in international do we should expect? Well, the group's going down from GBP 3.8 billion to GBP 3.3 billion, and the U.K. is going down from GBP 1.6 billion to GBP 1.3 billion. So it's GBP 300 million for the U.K., GBP 200 million for international. Andrew? Thanks. Andrew Kasoulis from Credit Suisse. I have got a question on the return on capital outlook, if I may. Firstly, can you give us a bit more of an indication about the sustainable level of growth in terms of sales? You talk about a more sustainable level of growth. We used to assume the U.K. could grow mid-single digits and international could grow mid-teens and overall blended, that was about 10%-ish. Presumably, there is a lower number now that you are basing your return on capital calculation on. What else in the numerator has got to improve a lot to still hit your target? I accept there will be a bit of a divot in year one, but to get to your years two and three numbers, presumably, there has got to be a significant contributor to the numerator. What is it of the various different levers? Is it U.K. like for like? Is it the bank? Is it the U.S.? Is it Europe? Is it less losses in China? How can you prioritize those, please, to grow that numerator? You are all looking at me. Yeah. Laurie. Thank you, Andrew. Well, as I said in my speech, ROCE will go back a little bit in this year because of the big investment that we're doing in the U.K., and you've reflected, I think, pretty closely our view on profit growth for the group in the consensus. Going forward, if I just pull that, let's say, three exceptions that will help the ROCE improve somewhat. So the U.S. getting to break even. Now all the bank provisioning is out the way and the migration is pretty much out the way, getting the underlying growth at 20% year on year, which you can see the baseline profitability is growing by that already. The Hungary crisis tax, which is GBP 38 million, it's a significant amount for Hungary. That's got a sunset in 2014. If you just took those three exceptions, they add 100 basis points to the ROCE. That would take it from 13.3 to 14.3. Now, of course, a lot of the discussion and plans that we've laid out today is a far lower capital-intensive growth, both for Europe and for Asia and, of course, for the U.K. So I'm pretty sure that the remaining 30 basis points that would take you from 14.3 to 14.6, we should be able to do. Now, before we reset the U.K. and set a lower level of growth, then there were much more avenues of getting to 14.6%. So it is more challenging, but we believe still doable. Your question about what's the blended growth rate, it used to look at double digit. It will be below double digit. We see it as high single digit, but of course, it will be at a much lower level of capital. So healthy growth, but more importantly, healthy returns as well. Not more importantly, as important. Healthy returns growth as well. Andrew, is it okay if I add something? Yeah. Yeah. Thank you. It would be good if we got an economic tailwind for once. We have had headwinds for 5 years. Consumers have never felt it more strongly than they do. Think about the winter. The winter of high fuel prices, of greater job insecurity, of higher levels of inflation. I think when we were sat here 18 months ago, we were thinking that was a thing of the past soon, but it isn't. Laurie's absolutely, completely right. Good single digit, not double digit. But if you get an economic tailwind, especially in the developing markets, that can change very, very quickly. That would be the thing that I would add to your brilliant answer. Thank you, sir. Thank you. Next question. Jeff? Hi there. Jeff Rattle, Morgan Stanley. Laurie, you mentioned in your presentation that you have taken much lower accruals for staff bonus payments. I just wonder if you could quantify that for us. Thank you. Yeah. So on the staff bonuses, the profit share that we pay to our frontline staff, there's no change to that. That will be the same as we've paid in normal years. But obviously, our management bonus scheme, the 5,000 that get a performance-related bonus in Tesco, it's a very transparent set of targets, which, of course, we've missed our own internal targets. Not only have we missed the annual targets, but when you look at our three-year targets, there are some schemes we just can't get to based on the last two years of growth. So it's been quite significant. The benefit to the second half has been over GBP 100 million of bonus accruals released. Now, some of that does come back in the 12/13 year, not all of it, because as I said, some of the multi-year schemes just won't pay out now. Great. That's very clear. Thanks. Clive next, and then Dave, please. Two, three questions, if I may. Firstly, Laurie, in terms of becoming a more cash-generative business, do you think that allows you to say anything about future dividend policy and also the possibility of returning to a share buyback down the line? Secondly, in terms of Tesco being a portfolio of businesses, but perhaps coming back to Phil Dorgan's question on Fresh & Easy, but also maybe the bank and even you as an Asian business, do you see the prospect of shareholders gaining some form of reward for their loyalty in terms of potential listings or potential realizations for the businesses you've created? Could you list Fresh & Easy in the States? Could you list Tesco Asia in Hong Kong? Could you list the bank somewhere else or whatever? Is that part of your thinking in terms of generating value for Tesco PLC and its shareholders? Only two, Clive. You said three. I'm just a little depressed because Coventry lost to Millwall last night, so I forgot the third one. Well, you are right to point out to me my emphasis on cash generation, because I do think it's a very positive aspect of the flight path for the business. Eight of our 12 international businesses, if you exclude Japan now, are all cash generative. They can either support their own CapEx and growth, or they can return cash to the group. That's quite a change. The bank is at the end of its investment through migration, and we've shown you what we're doing in the U.K., vis-à-vis lower CapEx, but it's always been a very cash generative business. Now, that's the plan, and there's a lot of heavy lifting to do between now and that coming in. When it comes in, that's the right time to have the conversation vis-à-vis share buybacks or dividend policies or whether we've got a better idea of investing that money for you in a better returns way. If we could park that, we'll come back to it when we show that it can be done. On the plans for listing, we don't have any separate plans for listing any parts of our business. As you saw with the Thailand PFPO, there is a big appetite from Asian markets, really, for the strong businesses that we've got in those various countries. The only plan that we've got at the moment is, if you like, returning that to you via property profits, getting our underlying profits going, which then feeds through to dividend, and it'll help us build this cash agenda that I've been talking about. No plans currently to separately list. I think, at this point, our real focus should be on an improvement in the U.K., Clive. That's so important. That's where we deliver the best value fastest for shareholders. When we get beyond that point, we can think about other things. Dave? Dave McCarthy at Investec. A couple of things. First of all, the chart you put up, which showed the return on capital you put up a year ago, showed the U.K. business as having round about an 18% return on capital. Of course, when you put that up, the U.K. margin was 6.2% approximately, and now you said the long run margin is going to be 5.2%, they get some growth. You've talked about the areas of the business where returns are going to go up, but are you now saying that long run returns in the U.K. will be below that level? That's the first question. Second one, you're pulling back on your space openings for the U.K. new stores. What would you do if the competition accelerated their openings because the price of sites goes down and greater availability for them? Would you just carry on and allow them to strengthen their strategic position, or would you reconsider your own opening program? I think on the long run returns, Laurie should answer that, although I would preface it by saying you should also realize that that bar in that chart, which represents the U.K., has GBP 10 billion of capital employed in it. In that GBP 10 billion is GBP 2 billion of unproductive work in progress, which will become productive. Without making a forecast, there is a significant positive out with a trading element to it in terms of the U.K. return. Yeah, I get that, but the question is about the, maybe I didn't phrase it right, is that the mature element of your business rather than that. Okay. Your mature element must be doing greater than 18%. Yeah. Okay, Laurie, do you want to deal with the returns question You got the first part of the answer, didn't you, Dave? You are right, it is more challenging to hold 18% ROCE, certainly in the short term for the U.K., and it will come down a little bit. The aspects that will make the return on capital employed go back up, of course, while margin is coming down, the numerator is a combination of quantum profit and margin. Our objective going forward is to grow profits in line with sales, not grow sales a little bit, but margin a lot. It is merely, over the long term, a switch of that strategy. That should hold the ROCE. There are other smaller elements within the U.K. P&L. For instance, the Tesco Direct business does lose money at the moment, and our plans to turn that into profitability come over the next 2-3 years. That will be an important contributor to the numerator as well. Steve's point is a very important one. Halving 2 billion of capital employed is pretty significant to the denominator in that calculation. The final bit is, as you know, George Osborne has been dropping the corporation tax for us. The ROCE that we have shown you is after tax. The tax, as you know, has dropped from 28% and it is going towards 23%. That will all be accretive to ROCE in the U.K. and help us a little bit. Phil, on space. Well, we won't change our view, Dave McCarthy. I think, as I said a little earlier, on space for the U.K. going forward, I'm thinking much more about the business we need to be in five and 10 years' time, a sustainable, profitable, returning business. I'm reflecting both the structural change in the way that customers are living their lives and the way that they're shopping, and the capability that you need to build online in order to service that, as much as I'm reflecting the fact that they're going towards convenience. I really like the store portfolio I've got in the U.K. I really love where those stores are located. I can see, as I said a year ago, that there are places where Tesco isn't, and it could be. I think that actually in the future, they won't be 80,000 sq ft. I think they'll be where there's demand, but they'll be smaller because we'll do more of the non-food online. If the property values do reduce, which I'm not sure they're going to because there's very short supply and very complicated planning regulations are getting in the way. It's not a completely free market here, as you know. If that were to happen, I think we'd stay where we are because I think we're doing the right thing for Tesco, for our shareholders, and for the business in general, which is making a change to be a clicks and bricks retailer at home. Structural change. Sure, we've got an execution problem. I talked about that last year. Fixing the execution problem will improve our performance of our existing stores. But actually, what I'm really seeing now is you can service people with products that they want online. You can increasingly do it efficiently. This Click + Collect thing is quite a change. Two years ago, we were delivering to people from a warehouse to their home through a courier who charged us quite a lot. Quite often, when they tried to deliver, the customers weren't at home, so all they got was a bit of cardboard. Now suddenly we've just had them pick them up in a shop. It is quite a change, and we thought long and hard about this. We've looked at every scheme we've got in our planning machine, and we've thought about which of those we should carry on with, and most of them we should. But smaller and more online, more digital. Not the death of the hypermarket, just fewer, newer, bigger, and more focused. I don't know how the competition will react, but I think because of our ubiquity, we're ideally placed, and I just think giving more to existing customers will get us back to generating more value for shareholders at home. I should just close, this is a very important point for me, by saying that the inheritance that I had was extraordinary. We've got the best network of stores in the U.K. But we've got the best network of stores in Thailand and in Malaysia and in Korea, and we've got the best network of stores in Hungary. We're ideally placed. But you can see the shift now. It's more to convenience in the U.K. It's more to online. That's going to be the way it's going to be for the future. That's more capital productivity for us if we can create the right digital assets. So much of our effort these days goes into that. Much more of it, though, goes into improving the U.K., which I know is dear to everybody's hearts, not least mine. James Anstead Thanks, James Anstead from Barclays. Just two questions. The first one, which Philip answered in part, I think. But on real estate, unless I've missed it's the first time in several years you haven't updated us on the value of your real estate portfolio. So I wonder if you could let me know what that is at the moment. Also, whether having told the market that you are less enthusiastic on opening big stores going forward, whether that has affected the appetite of investors to take that property off your hands, and whether, finally on real estate, whether you are planning at all to change the pace of divestments you highlighted this time last year in that ROCE plan. Secondly, on Asia. Clearly, your Asia margins expanded very nicely again, and that has been a big help to the group profit. But short of turning around China, which does not sound like it is going to happen in the very short term, do you think we can expect that Asia margin to improve any further, or is it starting to top out? I think if we should deal with the margin point first. Do you want to deal with that, Phil? Yeah. Asia margins were amplified in the year by the fact that we did not hit our sales in Thailand because all those shops were shut. We put in the insurance claim that offset the damage. I think that is an artificial inflation of the percentage margin, but not the cash margin. So, percent margin will probably ameliorate a little in the year that we are in. But I think you will still see expansion because you have a lot of immature assets, James, that are coming through. You make a good point about China. We hope that we would see it turn positive. We are still investing in overhead. The consumer has found it very tough, and all retailers have. So we still see opportunity for margin expansion, not rapid, from Asia. On real estate. Yeah, I think if I am calling your question right, James, it was enthusiasm amongst investors for big stores? Well, you said that you are less, not committed, but less enthusiastic about the big stores. I wonder whether the people that are buying them from you are so keen to accept that kind of yields in the past. The answer is I don't think so, but I'm sure Laurie can answer that question. Yeah. The sale and leaseback program in the U.K. is still delivering yields in the mid 4.5s to 4.75, so very healthy. And of course, appetite is partly attributed to value, but also to the inflation that you've got on rent and the company's underlying ability to pay the rent. So that kind of drives the value just as much. The value of our property, I'll say what I think it is, and then we should just double-check. But the market value of the group's properties is about GBP 26 billion, and the net book value of it, I think is about GBP 18 billion. So we've still got a significant market value excess over net book. One of the things about these stores I think James is looking a bit confused there, but Well, you said it's 36 last year. That's the total value of all of the assets that we've got. So that adds back in malls, distribution centers, other assets, the width. But I thought your question was specifically about trading property. Yeah. It's about the same. Well, let's clarify that. We did look at that only yesterday. Yes Didn't we? I was going to say about the stores is they're great locations and they're scarce assets. And so that creates its own market. Mark DeSelbe? Mark? Yeah, Mark DeSelbe, Redburn. Just two questions. Firstly, can you give a bit more detail then on where you think the profitability of non-food online could or should get to, and what is needed from you to do that? From your smile, I am wondering, do you have a clear enough view yourself of what is needed to get there? Maybe a sort of range currently where you think the profitability, both in terms of margins and ROCE, could get to, and what you need to do to get there, and some sort of outline of the timeframe. That is the first question. Second, just your view on the current margin environment in the industry overall in the U.K., the overall level of competitiveness. It would seem from the recent food price inflation seems to be a bit stickier as in supplier prices are going down recently. How sustainable is that going forward? Do you want to deal with the second one first? Do I? Yeah. How's that? Topic du jour. Okay. I think it's still a very competitive market. Of course, I do. I see the pressure of inflation in pricing continuing and retailers working hard to press it down. As we've said, we're calling our operating margin in the way that we are because we've given ourselves some room to make sure we remain competitive. You can see for me, competitiveness isn't merely price, it's the price quality-value equation. Our inflation rate's slightly below the numbers that get externally reported because we did that Big Price Drop to prices last year. So we feel pretty good actually about how we're delivering value to customers, and you'll see some changes in the near future to that. Does that answer your question? You're looking blank at me, which suggests I'm right or not. Sorry, that was my best attempt at a cunning look. No. That's the normal reaction I get. Phil, I'd ask you more about the general industry environment, and we have noticed if you look at just straight ONS, CPI food against PPI food, the CPI, the retail price inflation has been staying up higher. In fact, ticked up in March according to ONS yesterday, whereas the input costs are still coming down according to that particular measure. Other retailers seem to have suggested that the overall margin environment is not quite as tough as it was back end of last year. Ex what you're doing, do you recognize that as sort of overall comment for the industry? If so, is that something that could sustain through the year? I should have thought even a casual look at the tabloid press would tell you that. It was in Metro this morning, actually, so it is a very silly old question. Yeah. I knew. Profitability of non-food was your second question as well, wasn't it? Non-food or Tesco Direct? Non-Food Direct. Non-food online, multi-channel. Yes. I understand why you have to ask that question. We are not going to get drawn on our profitability for the online business, but if I could just describe the components that improve profitability, hopefully that will give you the wherewithal to make your own judgment. The current business that we finished with last year, its mix orientation towards electrical is too high, and that depresses the gross margin of that business. We finished last year with, I think, 38,500 SKUs. If you went online now, and we have just relaunched the Tesco Direct website. It is far more functional, far easier to use from a mobile perspective. You saw in Philip's presentation. That has already moved to 80,000 SKUs. By the end of this financial year, pre-Christmas, we will be up to 200,000 SKUs. Some of that comes from Tesco Marketplace. A lot of it comes from our own ranges going online. They are much more gross margin accretive than the electrical business that we have. The second aspect is we have not been leveraging Tesco's scale in terms of distribution, and that is the biggest cost that a pure play has. They have to get it from their warehouse to the customer. We have given you a couple of KPIs today, but we deliver already to 2,400 stores around the U.K. every day. That is already baked in cost. We are going to leverage that system. Because customers want to pick up from our stores, and it surprised us how much of our order choice is, "I will just pick it up from my local store." At the moment, it is 770 Click + Collect stores. 70 of them are Express. We double that by Christmas. It gives us an 80% coverage of the U.K. in a five-minute drive time. Very extensive coverage. As I say, costs that we are currently paying to a third-party operator to do it for us gets leveraged off our own cost base. Then I think the third piece, which is also a leverage scale, we have 33 buying hubs around the world buying non-food for us. You have heard us talk a little bit about bringing all that together for the group. That will help us in terms of buying margin as well, not just for the U.K., but for all the other dot com businesses that we are doing around the world. I could just add a bit more color, perhaps. Our toaster broke at home a couple of weeks ago. This is strategy, this. I am getting into the detail. So I went on my smartphone. I bought a Tricity red, Liverpool supporter, you see, toaster and kettle. The Tricity brand is owned by Tesco. It is manufactured in one factory in China. It is bought through our buying hub. It is sold in every business we own in the world, apart from Korea, because of some legislation about electricity I do not quite understand. It was delivered to my Cuffley Express store the next day after I had ordered it on my smartphone. Two years ago, I would have gone online, would not have been able to use my smartphone. I would have ordered it. It would have been delivered to my house. It would not have been Tricity because we did not have the brand then. It would not have been made for the group. It would not have the basic margin it had. It would come to my home. It would go through a courier. It wouldn't go through the Tesco supply chain, all that cost. As you were saying, Laurie, absolutely right. It's the 33 buying hubs, buying once for the group, developing a product that's got some intellectual property in it, some real value, getting it to the U.K. into our Middlesbrough DC, which Laurie built a few years ago. Then moving it through our store network to the Express store takes out a lot of cost. You got bigger gross margin at the top, you got lower cost at the bottom. Then, as you rightly said, when we began with Tesco Direct online, it was mainly consumer electronics. There's little margin in flat screen TVs, particularly if the way that you sell them is high-low pricing. If you think about the way retailers work in brick stores, they high-low. It's one price, then it's discounted. Online, because of pricing transparency, you have to have a different way of doing it. You're buying with the selling price in mind. You're using web analytics to realize when you've got to shift prices. All these capabilities we've been developing, learning from some of the best. Then you add Marketplace, because with Marketplace, you suddenly get a view of what actually is selling, because all we know is of the things we're buying, what's selling. With web analytics, you know of the things that we aren't selling, that others are selling, what's selling, and you decide whether you want to sell it or not. As a retailer with so many years' experience, Tesco is able to create value and then use its superior logistics network to take cost out of every link in the chain and then make it more convenient for customers. The best thing of all is the toaster worked. Caroline, and then Christine. Very good. The bank sorted it. Hi. We can do that sort of internet banking. Hi, is that working? Yes, it is now. It's Caroline Gulliver from Espírito Santo. Two questions, please. The first is on your marketing strategy in the U.K. Can you give us a bit more color on why dunnhumby was de-emphasized and now it's being re-emphasized? What's actually going to change? How can we have confidence that you're actually going to get it right, effectively from now on? I'm assuming you're going to talk about more personalization for the consumer. But the GBP 5 off GBP 40 shop doesn't seem to be that. So what's going to change and how can we have confidence you're going to get it right? Then the second question is really clarification on your definition of success. You've obviously got the return on capital target. You've made lots of points about growth successful. In the U.K., given that you've said you're making all this investment in online and in the stores, and you've talked about sales growth leading profit growth, does that mean that your definition of success includes market leading like for likes and not just market being in line with the pack? I think both of those are for you, Phil. Very kind of you. Personalization, dunnhumby. Marketing in general. The fastest way to get a sales uplift if you are running around looking for sales is GBP 5 off 40. You saw what happened in the industry at Christmas, saw that we weren't there. I don't like doing that very much, but when it's done to me, without the ability to have any other immediate reactions, then it's the right thing to do. We are doing an increasing amount of personalization already. You'll only know about if you are a Clubcard customer and you shop regularly with us. We have other ways of maintaining and building the loyalty of our existing customers. dunnhumby is right at the heart of that. What you have to do is take some of your promotional investments and move it. Move it out of five off 40. Move it off 6p off a liter of petrol if you spend GBP 50 or more. Move it off high-low promotions. Move it into targeted promotions personalization. That's what you'll see us doing. In our plan for the U.K., some of our investment is just that way. Dunhumby. He's passed me something that I don't really want to say, but go on then. I'll trust you because you are good at numbers. Three weeks ago, we mailed 7 million customers. I don't think you know that. We mailed 7 million of our most loyal customers with a loyal customer mailing. We know that's going to improve loyalty. We'll take that much, much, much further because we'll start to tailor ranges in stores. I don't want to talk about why they weren't at the heart of it. I think we were doing quite a lot, but the truth is we can do a lot more, and do a lot more we will be doing. I don't know if you follow the blog sphere any, but when we did the first little customer mailing, I well remember one customer saying, "At Tesco, they know me so well. They've sent me hair removal cream vouchers and loads of money off chocolate." That's an example of because you understand how customers behave, you can give them a reward that really means something for them. That's what I mean about personalization. You then asked about success. I'm not going to be drawn on that, really. I understand why you have to ask it, but I listen to what customers say, and I get a feeling for whether we're doing the right things or not, and I'm determined that's what we do. We've laid out a very ambitious plan. We're very confident of its delivery, but it does require executing, and that's what we're in the process of doing. I'm sure you'll get the opportunity to ask that question time and time again, and I'll answer it when customers are showing it in like for like. Kathleen O'Leary at Oriel. Just coming back to the online grocery business, can you say for the stores that actually have that facility, what percentage of sales that is now up to for the stores in question? And whether, for those online orders, how much more profitable is it to get people to come to the store and pick it up for those online orders? To pick it up? Yeah. Well, food Click + Collect in-store is clearly more profitable than having to deliver it to a customer's house. I'm not going to say by how much, but it clearly is. What's fascinating about it is for certain housekeepers who have very active lives and children to look after, it's amazingly convenient because they haven't got to stay home. They may be taking the children to school in the morning, they may be doing something in the middle of the day, they may be picking the children up in the evening. At weekends, they may be out engaged in family pursuits, and they can just come to a Tesco store within a certain number of hours, they're free to choose, and pick up the groceries. So it's good for them. And they like it, and we like it. We've got time for two more. Sorry, so you asked the first part of your question was, how big is it? Well, in some stores, it is too big. Is the truth, because we have more people in the store taking things off the shelf to deliver to customers' homes than we are putting it on the shelves. That is where the dot-com only stores come into their own. Because by the time you have created such a powerful sales participation in a hypermarket, you can pull that into a dot-com only store. You are just shifting the trade from one unit to another, and you then free that store up to do a better job for its customers. That is when we do a dot-com only store. There are obvious ranging and productivity implications for the business from doing it. But actually, there is a big benefit because it just gives the stores a bit of room to breathe and to focus on the bricks and mortar customers. So that is another angle to it. Two more questions. Edouard? Yeah. Good morning. Edouard Aubin from Morgan Stanley. Just to come back on the international, in the fourth quarter, when I look at your like-for-like volumes in your international market, it looks like they were down in eventually all of your markets. In fact, in recent years, like in the U.K., you had like-for-like volume contraction in a large number of your international markets, again, if you deflate from CPI, while margins have increased, in Asia and in Europe. Aren't you running the risk that the margin could start going the other way, like in the U.K. with the contraction in volume? Do you identify that as a risk or no? Well. Okay. Yeah. You're right. At the moment, consumers are feeling the pinch, and so they are not spending on the big-ticket discretionary items that usually drive the top line. Underneath that is a very different picture between what happens in food and what happens in general merchandise and clothing. It is dangerous looking at it just at that one level, Edouard. We take great solace from the way in which those businesses perform in their different categories. Then, of course, there are young businesses that are growing in their maturity, in economies that if we get a bit of tailwind rather than the headwind that consumers have been facing for more than a few years now, then we think that we will be able to maintain our sales growth, get back to volume growth, and maintain margins where they are today, if not improve them. Laurie, as you heard him just mention in the answer about the internet, increasingly leveraging the skill and scale of the group is what we need to do. My example of the toaster and the kettle is not an isolated example. Most of the general merchandise that we buy for Europe now comes to the U.K. and vice versa. We are buying it once, and we are improving our buying capabilities, doing the same in food. There is a lot more to come in terms of our own productivity without just taking it straight from the customer, because we know giving value back to the customers is what matters most, particularly at these difficult times for them. Last one. Jason Mullins at American Investment Management. Just in terms of your balance sheet structure, given the margin weakness together with obviously an increase in your pension deficit and lack of deleveraging, how important is retaining your A rating? Obviously, Moody's have you on review for downgrade at the moment and maybe would review post these results. Maybe if you can give a bit of color on that would be great. On credit rating, it is important to us. We have given it a lot of focus. Moody's have put us on negative outlook. To be honest, their feedback to us is it is not as a result of our financial performance, the strength of our balance sheet, how we are making progress on all of those financial metrics, which has been pretty good really since 2008. Where, for instance, our RCF to adjusted net debt was just below 16%. We are coming up above 19% now, nearly in the 20% category, which is a safe A rating haven. What they are concerned about was more the reaction to our profit warning and how strong the U.K. franchise was. We were given very positive marks on the strength of the U.K. business as a market leader producing reliable profit growth. It is more that that has made them put us on negative outlook. Deleveraging, our gearing is going down quite quickly. Our gearing is about 38%. I have given the balance sheet a lot of discipline in terms of fixed charge cover, so even the adjusted net debt and the level of indebtedness. The level of indebtedness target we are getting very close to. We have got more work to do on fixed charge cover, but we are just below my kind of 4 to 4.5 at the moment. But overall, I think we have done some very good work on the balance sheet. It is much more disciplined than it ever was. And of course, this new phase that we are moving to in terms of lower capital-intensive spend, will help the balance sheet a lot as well. Thank you. Thank you very much. The IR team are around for the rest of the day if you have any more questions. Thank you. Thank you

Data Source: Quartr Last updated: Apr 18, 2012

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