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Rethink at Tesco as profits drop and the great space race stops

Tesco Ireland looks set to buy into business model changes as its parent company sees its first profit drop in 20 years.

The retail giant's appetite for world domination appears in retreat.

It is pulling out of the US and cancelling plans for huge new stores.

Tesco Ireland's focus is on small convenience stores, growing a thriving online business, combating an ever-greater discount chain threat and managing over-rented leases imaginatively.

In the last year to March, Kantar research shows Tesco Ireland's grocery customer spend growth stalling, gaining just 1.3 per cent to 28.2 per cent.

In the last three months, "Tesco has performed behind the market for the third consecutive month and now sees its sales declining by 1.3 per cent," Kantar's David Berry noted.

Strikingly, the consumer spend at rapidly expanding discounter Aldi shot up by 27.9 per cent in the last year.

"The marketplace remains very tough, with shoppers looking to cut back and offset increased prices," said Mr Berry.

"Tesco remains the number one player, with a strong lead over the competition, with Aldi and Lidl posting the strongest growth.

"Tesco.ie [online shopping] is becoming more and more important, contributing 3.6 per cent of overall sales and growing at over 20 per cent compared to last year," says Mr Berry of the first quarter of 2013.

It grew by 16 per cent in 2012.

Tesco is meeting challenges, according to Ireland boss Tony Keohane, but "we expect customers will continue to demand better value as household incomes remain stretched".

Pointing to the rapidly growing use of the smartphone by customers to shop, parent company boss Philip Clarke announced the decision to open fewer of the giant supermarkets that have defined Tesco's relentless expansion over the last two decades, scrapping 100 major store developments in favour of focusing on online sales.

"The space race is over," Philip Dorgan, an analyst at Panmure Gordon in London, said in a note.

"The focus is shifting to online and small store investment."

The type of stores opened last year by Tesco Ireland were the smaller convenience model – four Express stores and one Metro – and this year it will continue with its small format focus, opening six new Express or Metro stores.

The multiple has been proactively remodelling its boom-era leases, hashing out rent reductions through a lease-regearing gambit that slashes them by up to 50 per cent in some cases.

"Landlords are being sensible about this," said Declan Stone of agents Colliers International, which manages 3.5m sq ft of retail space.

An example: where Tesco might be renting a store with a €500,000 annual lease due to expire in three years' time, Tesco might propose to the landlord that it will renew the lease now, for an extended term of maybe 10 years, but at half the current lease price – say €250,000.

"In a shopping centre or retail park situation, it's much easier to sell leases to other tenants if you can say you have a secure, long-term, big-name tenant," says Mr Stone.

Landlords, receivers, Nama and other bank asset managers can see the financial sense of working with Tesco and other big-name retailers like Next and TK Maxx on this.

Irish Independent