Today I am explaining how Tesco’s (LSE: TSCO) new fight could prove disastrous for profit margins.
Cable on the offensive
The enduring saga over the way supermarket giant Tesco conducts itself came under further scrutiny this week, with news breaking that business secretary Vince Cable has written to the Groceries Code Adjudicator (GCA) recently for an extensive review of how the supermarket deals with its supplier base.
According to Sky News, Cable sent his request to the GCA in order to ascertain whether a connection can be made between Tesco’s relationship between its suppliers and its recent £263m profits overstatement.
The GCA was established by the business secretary back two years ago to supervise the relationship between the country’s largest supermarkets and their suppliers, dealing with complaints from goods suppliers and doling out fines to retailers if necessary.
Tesco in particular has long been in the crosshair of those who criticise the squeeze it applies to suppliers in a bid to attract customers with ultra-low prices. So news that the GCA has been officially requested to investigate the firm will come as a further headache for the firm, particularly as it remains engaged in an intensifying — and margin-shredding — price war with its retail competitors.
Frustration builds amid elusive recovery strategy
And unfortunately for Tesco, the introduction of mass discounting across the store appears to be the only tactic it has up its sleeve to stave off the charge of Aldi and Lidl. And the pressure on the business to continue cutting prices is only likely to intensify with J Sainsbury primed to enter the budget chain segment in the coming weeks through its accord with Denmark’s Netto.
Tesco’s lack of ideas was hammered home by Dave Lewis’ presentation following last month’s interims, when despite a sustained barrage from reporters and analysts he refused to divulge plans of how Tesco will regain momentum in the worsening grocery wars.
Given this seeming lack of a plan, City expect the business to punch its third successive annual earnings drop in the year concluding February 2015, with a colossal 46% decline currently pencilled in.
An additional 5% fall is expected the following year, although this forecasted improvement could come under the cosh should Tesco fail to start pulling rabbits out of hats, and fast. And with the Serious Fraud Office (SFO) also in the midst of a criminal investigation into Tesco’s dodgy accounting practices, I believe that the risks continue to outweigh any potential rewards for investors.