CtW Investment Group Asks Tesco Chairman-Elect to Review Strategy at Company’s Fresh & Easy Subsidiary; Questions Tesco’s Executive Incentive Pay Practices
By Ctw Investment Group, PRNEWednesday, June 29, 2011
WASHINGTON, June 30, 2011 -
-With photo
The CtW Investment Group is calling on incoming Tesco (LSE:TSCO)
Chairman Richard Broadbent to address investor concerns about
mounting losses at Tesco’s Fresh & Easy subsidiary by
conducting an objective and independent strategic review of the
U.S. business and to publicly articulate a strategy for
profitability.
In its 29 June letter, the CtW Investment Group also notes that
under the new remuneration policy, U.S. CEO Tim Mason’s incentive
pay will be substantially de-linked from Fresh & Easy’s
performance, raising questions about executive accountability for
continuing losses in the U.S. The CtW Investment Group also
points out that all executive directors will continue to have their
incentive pay linked to profits from the sale and leaseback of
property, which may potentially allow executives to “pick their
number” in order to hit performance targets.
The CtW Investment Group’s 29 June letter to the Tesco
Chairman-elect is below and can be found at
June 29, 2011
Richard Broadbent
Chairman-elect
Tesco PLC
c/o Barclays PLC
1 Churchill Place
London UK E14 5HP
Dear Mr. Broadbent,
We call on you, as the incoming Chairman of Tesco’s board of
directors, to lead the board in an objective and independent review
of Tesco’s Fresh & Easy operations in the U.S., and to publicly
articulate a strategy to deliver on the company’s repeated promise
that Fresh & Easy will “break even” by 2013 (and presumably be
profitable thereafter).
We believe that the board must undertake this strategic review
not only because Tesco’s existing approach to the U.S. market has
been notably unsuccessful, but also because, with the changes made
to the Tesco executive remuneration policy by the Remuneration
Committee, the Fresh & Easy CEO, Tim Mason, no longer has his
remuneration tied directly to the performance of U.S. operations or
to the achievement of expansion milestones.(1) The original
purpose, as stated in 2007, of adding U.S. award objectives to Mr.
Mason’s pay package was to incentivize the U.S. CEO to deliver a
strong and profitable U.S. business in a challenging retail
environment. Given that Fresh & Easy remains unprofitable
and that the U.S. retail environment remains challenging, it
appears Tesco has simply dropped the idea of linking executive
performance pay to the performance of the U.S. business in any
meaningful way.
Since Mr. Mason has been responsible for leading Tesco’s efforts
in the U.S. market since their inception, delinking his pay from
Fresh & Easy eliminates the primary mechanism through which
Tesco executives were in any transparent way held accountable for
poor U.S. performance. Of course, as we have pointed out in
letters to your predecessor and current Chairman David Reid, in
practice it appears that Tesco did not meaningfully hold Mr. Mason
- or any other Tesco executive - accountable for Fresh & Easy’s
substantial and ongoing losses, and instead “moved the goal posts”
to enable Mr. Mason to enjoy handsome remuneration despite Fresh
& Easy’s evident struggles. This year, for example, the
Remuneration Committee awarded Mr. Mason a bonus worth 80% of his
salary even as the U.S. results disappointed and trading losses
increased for the third consecutive year.
Additionally, our communications to Mr. Reid argue that overall
executive remuneration at Tesco appears to have been inflated by
the inclusion of property profits from sale-leaseback transactions
in the performance measures (particularly EPS) used in Tesco’s past
executive pay plans. In our most recent letter, we noted that even
a shift to Return on Capital Employed (ROCE) as a performance
measure would not ameliorate our concern that executives can “pick
their number” and undertake more or fewer sale-leaseback
transactions in order to hit their targets.
The CtW Investment Group works with pension funds sponsored by
unions affiliated with Change to Win, a coalition of U.S. unions
representing nearly five million members. These funds have over
$200 billion in assets and are substantial long-term Tesco
shareholders.
We outline our concerns below.
Fresh & Easy’s Continued
Struggles
“I look at the plans and the plans
are persuasive. But…there is a big shift required if we are not to
get to your doomsday scenario and a billion [pounds] of accumulated
losses. Now, the plan doesn’t say that, so deliver the plan.”(2)
Philip Clarke, Tesco CEO
Ever since Tesco’s first stores opened in the U.S. in November
2007, the company has claimed that the reception by U.S. consumers
has been very positive, and that profitability was just over the
horizon. Despite these claims, as Figure 1 shows, Fresh &
Easy’s trading losses have increased every year, even as sales have
grown.
(Photo:
These losses raise questions about the Fresh & Easy business
plan and its implementation. The U.S. business has
consistently failed to meet expectations: In fiscal 2008/2009
losses from U.S. operations were 142 million pounds Sterling, or 42
million pounds higher than projected. The following year U.S.
losses climbed to 165 million pounds even though the company had
expected a “similar loss” to what was experienced in the prior
year. In 2010 Tesco said it believed that Fresh & Easy
losses had peaked; however in 2011, the company once again reported
higher than expected losses of 186 million pounds. The
number of store openings has also fallen considerably behind the
Company’s projections.
Tesco has frequently suggested that Fresh & Easy’s losses
should be attributed to the considerable start-up costs associated
with Tesco’s first major commercial venture in the U.S. For
instance, in its 2009 Annual Report, the company asserted that it
would achieve profitability after opening 300 U.S. stores.
However, not only has the pace of expansion in the U.S.
slowed sharply, but the increases in scale that have been achieved
do not seem to be delivering improvements in profitability.
Table 1: Fresh & Easy Growth Not On
Target (Pounds Millions)
Change in Trading
Change Change
Change in Sales per Profit
per
in
in Trading Marginal
Marginal
Stores Sales
Profit Store
Store
146.00 -23.00
2009/2010 30 pounds
pounds 4.87 pounds -0.77 pounds
148.00 -21.00
2010/2011 19 pounds
pounds 7.79 pounds -1.11 pounds
——— — ——-
——- ———– ————
As Table 1 illustrates, while Tesco’s newly opened stores over
the past year have been associated with an overall increase in
sales per store, they have also been associated with increasing
losses per store. Tesco is projecting that Fresh & Easy will
“break even” sometime in the 2012/2013 fiscal year, without any
clear indication of why shareholders should have confidence that
this goal will be met. Given that increases in scale so far seem to
have done little to improve profitability, we are skeptical that
the current strategic approach can achieve even its relatively
modest goals in two years time.
This skepticism about Fresh & Easy’s prospects finds support
in the published views of many analysts following Tesco, who point
to the substantial challenges Fresh & Easy faces in winning
over U.S. consumers and generating a return on investment
commensurate with the Tesco’s large U.S. investment.
More specifically, analysts have questioned whether
like-for-like growth at Fresh & Easy is driven mainly through
extensive use of discounts and promotions, such as $5 off coupons,
which represent a substantial percentage of average customer
purchases at small format stores such as Fresh & Easy. Mike
Dennis of MF Global questioned the wisdom of opening stores in
Northern California that are supplied by daily deliveries from the
company’s distribution center in Riverside, located hundreds of
miles away. Others have questioned the heavy reliance on
in-house brands in a supermarket culture where the private label
offer is widely considered to be inferior in quality.
Crucially, while Tesco has clearly made its share of mistakes
entering the highly competitive U.S. retail market, it has
compounded its errors by alienating some stakeholders, including
vendors and their trade groups, community organizations, Fresh
& Easy employees and trade unions. For example, the
respected “Perishable Pundit” blogger Jim Prevor has written,
“Tesco elected to alienate many suppliers when it broke the produce
trade’s cultural pattern by refusing to join trade associations…”
(3) Prevor has also published extensive commentary from industry
members highly critical of Tesco, such as:
”…one reason everyone is so interested in Tesco’s
adventures is because of the way they treated the potential U.S.
suppliers and the market place. When suppliers were interviewed,
there was a level of arrogance and bullying that most of us hadn’t
seen since we were on the playground in grammar school.”(4)
Rather than spend two further years on a strategic trajectory
that does not appear promising for numerous reasons, we believe
that the board must undertake an objective review of U.S.
operations, and determine what changes in strategic direction are
necessary to turn Fresh & Easy around.
As part of this review, we urge the board to meet with key
stakeholders - including consumers, vendor associations, community
leaders, elected leaders and representatives of organized labor -
in the areas where Fresh & Easy has established operations, in
order to ensure that it is fully informed of the public perception
of Fresh & Easy, and any obstacles this perception may present
for future growth. While Fresh & Easy is currently only a small
portion of Tesco’s overall operations, the U.S. market clearly
presents enormous growth potential for Tesco if it can adopt a
viable strategy going forward.
Property Profits and Executive
Remuneration
As we explained in our May 16, 2011 letter to Mr. Reid, we are
concerned that over the past several years, but especially
following the 2008 financial crisis, a disproportionate and growing
share of Tesco’s profit before tax has been generated by
sale-leaseback transactions. Since profit before tax is a key
determinant of overall earnings and earnings per share, it appears
to us that even with Tesco’s adoption of a new remuneration plan
focusing on group-wide ROCE, executives could have the ability to
“pick their number” and undertake a higher quantity of
sale-leaseback transactions in years when core retail operations
have not generated the earnings necessary to hit remuneration plan
targets.
Other analysts have questioned the use of property profits in
determining executive pay levels. For example, in its recent
analysis of remuneration at Tesco, PIRC asserted that mature
property sales are not “indicative of sustainable operational group
performance,” and that including property sales in metrics to
determine bonus pay outs under the long term performance scheme “is
not appropriate.” (5)
As we have stated in the past, we continue to urge the board to
clearly distinguish retail profits from real estate profits, and to
base remuneration solely on the former. Since transmitting our May
letter, we have noted that Tesco has committed to keeping property
profits within a range of 250M pounds to 350M pounds (i.e., below
the level of the past two fiscal years). However, as far as we are
aware, Tesco has not disclosed any change in practice with respect
to counting such real estate profits toward executive remuneration
targets, and so our concerns remain. We enclose a copy of our May
16, 2011 letter to Mr. Reid for your review.
We understand that as a newly incoming director and Chairman,
you may feel chary of immediately challenging the strategic
decisions taken by incumbent managers and your fellow board
members. Nevertheless, we urge you to do so in order to ensure that
Tesco shareholders fully support the company’s executive
remuneration arrangements and have confidence in the best position
possible to realize the potential of U.S. expansion. If instead
Fresh & Easy continues to stagger along with mounting losses,
we fear that Tesco may abandon the U.S. market and leave its
considerable potential untapped. In our view, that outcome may be
avoided by a timely assertion of your role as Chairman in providing
much needed strategic advice to management on a critical but
troubled long-term investment.
Sincerely,
William Patterson
Executive Director
cc: Tesco PLC Board of Directors
** Note: For additional information or comment please
contact Ed Keyser at
or at +1-202-721-6063.
**
CONTACT: Ed Keyser (US), 00-1-202-721-6063
(1) Tim Mason is not a member of the Tesco PLC Remuneration
Committee. The company states that “no member of the
[Remuneration] Committee has any personal financial interest in the
matters being decided…nor any day-to-day involvement in running the
business of Tesco.” Tesco 2011 Annual Report p. 75. Tim Mason
was recently appointed Deputy CEO and Chief Marketing Officer of
Tesco in addition to his continuing role as President and CEO of
Fresh & Easy.
(2) Financial Times, “Leahy planned for 10,000 Tesco stores
in US,” 9-19-2010.
(3)
www.perishablepundit.com/index.php?date=02/27/09&pundit=4
(4)
www.perishablepundit.com/index.php?date=03/12/09&pundit=1
(5) PIRC Alerts, 6-21-2011, p.1.
.
Tags: Ctw Investment Group, District of Columbia, June 30, Washington
