Tesco - A Story Within A Story

Tesco stock has been lit up like a Christmas tree, up 9.8 percent at 199p on heavy volume trading (at the time of writing this piece).

After a dismal 2014 with the accounting scandal, where the company overstated it profits by £250m, and dismal trading figures, Tesco is now determined to show investors that it is starting 2015 on the right foot. There is certainly change in the air at. A change of the guard has taken place. Out with the old Tesco Chairman Richard Broadbent, tainted by the accounting scandal, or better said ‘fraud’, and in with Tesco's new great white hope, Matt Davies, Group Chief Executive of Halfords Group plc which will be effective 1st June.

The new CEO reckons he can turn around the UK giant retailer. Indeed the Tesco Board of Directors has big plans, but it is not going to be a walk in the park.

"We have some very difficult changes to make", said Chief Executive Dave Lewis. "Our recent performance gives us confidence that when we pull together and put the first we can deliver the right results."

So what is on the cards at Tesco?

The retailer will be launching an aggressive cost cutting program.

43 unprofitable stores will be closed, most of them will be the small metro stores with hundreds of job losses. Administrative staff will also be reduced with the consolidation of head office locations.

Some divisions of the business will be sold, for example the sale of its Blinkbox movie streaming service to TalkTalk PLC for an undisclosed fee.

The retailer also said it would launch a cost-savings program and reduce capital expenditure to GBP1 billion in the 2015/16 financial year.

Moreover, balance sheet building will also be part of the Board's strategy. There will be no dividend payments for shareholders this financial year and no pay rise for workers either.

Then there is the re-establishing of its identity as a value for money grocery store, being in the middle, between an upmarket food grocery and a discounter was like operating in no man's land. So Tesco will be embarking on aggressive discounts similar to its near rival Asda, which is pumping £300m into lower prices.

So the new CEO has a plan to turn the giant retailer around. Although, behind all this euphoria of change in the air at Tesco, the question is whether the new CEO can pull it off.

In a sense, Tesco's problem is a story within a much bigger story. What we have witnessed, following the 2008 financial crisis (the worst in living memory) is a radical change in wealth distribution, not just in the UK, but in all of the western developed world economies.

The monetary policy followed by the major central banks to tackle the 2008 financial crisis has saved the financial markets, but it has come at a huge cost. Quantitative easing (QE) doesn't actually do much for the real economy. It hasn't made credit more available for small businesses and it hasn't boosted real economic activity. If QE worked, Japan would not be in a depression right now. Admittedly, QE has been remarkably successful in fuelling asset bubbles and enriching a tiny elite group who are near the source of the money creation. This has created a Goldilocks economy, where the money just circulates around an elite circle, excluding those in the real economy.

That is why consumption in the real economy is down but demand for luxury goods is high.

In other words, this has created a two tier system of consumption. Businesses offering super luxury products have performed beyond their wildest dreams. The luxury car market has never had it so good. Rolls Royce has had a record year. Art Galleries selling multi-million dollar paintings also had a record breaking year in 2014. Diamonds being sold for record figures in the tens of millions. Meanwhile, businesses catering for the middle range customer have been struggling to keep afloat. However, on the lower end (which is now the new middle) sales have been going up. So the super luxury and cheap and cheerful are doing well but the middle range retailers are shivering.

That is why, in food grocery talk, upmarket Waitrose has done well and equally the discount supermarket Asda has had a good trading year.

However, make no mistake about it, the cheap oil is going to do what QE failed to do. Put money in the pockets of people living in the real economy, which is already boosting consumption.

“In Europe, total sales increased by 0.4% at constant rates for the 19 week period, excluding fuel. The like-for-like sales performance for the region, though still held back by our performance in Ireland, improved from (2.5)% in the second quarter to (1.2)% in the third quarter. Further improvement in all markets resulted in positive like-for-like sales growth of 1.0% for the Christmas period,” according to recent Tesco statement.

I wouldn't be surprised to hear more good news from Tesco soon as cheap oil starts feeding through to the economy, bearing in mind that more people just might take the car and drive to Tesco for a few items, rather than use the local convenience store, now that fuel is cheaper.

However, keep optimism in check. The caveat is that Tesco is not operating in a monopoly market so they can't extract monopoly profits. Attracting more customers by lowering prices is good for the consumer, but for the retailer it could trigger a price war and that will eat into their bottom-line.