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Why Tesco’s Finest* convenience stores make perfect sense

Aldi and Lidl have been the runaway success stories in the supermarket sector in recent years, but the likes of Waitrose and Fortnum & Mason have more than held their own

tesco finest crisps
The potential 7% margin is double Tesco’s current margin target

Tesco PLC (LON:TSCO) is mulling a move into the upmarket supermarket space as part of plans to boost its wafer-thin margins.

The FTSE 100 retail giant currently pitches itself somewhere in the middle of the supermarket class system: not quite as posh as Waitrose, yet classier than Aldi and Lidl.

READ: Tesco aiming to boost margins and enhance cash growth

Those last two, the German discounters, have transformed the way we shop in recent years. In January, WM Morrison Supermarkets PLC (LON:MRW) said it had seen a “change in consumer behaviour” as cash-conscious consumers look for more bargains, and rivals, including Tesco, have also noted this shift.

The result is more deals and cheaper prices for us, while the supermarkets have had to slash costs just to maintain their already-squeezed profits.

Supermarket margins are under pressure

To give you some idea of how tough the grocers are finding it, Tesco makes less than 4p for every pound spent in its stores. J Sainsbury PLC (LON:SBRY) pockets less than 2.5p on every quid.

Tesco has spent much of the past five years on the back foot, thanks to an accounting scandal back in 2014 which shocked Britain’s biggest retailer to the core.

Under chief executive Dave Lewis, the business has been steadily rebuilt, with ‘Drastic Dave’ taking out the knife and trimming the cost base.

At April’s full-year results presentation, the former Unilever man praised his company’s turnaround, and rather than thinking about what can be cut, his focus now seems to be on how Tesco can grow.

A Finest* convenience store coming to a town near you (maybe)

Last autumn, Tesco opened its first Jack’s store – a low cost supermarket that was seen as a direct attack on Aldi and Lidl.

The company refuses to say what its long-term plans are for Jack’s, and Lewis himself has said he is treating it as a trial to gauge the public’s response.

He is now setting his sights on a very different part of the market. Rather than sticking it to the discounters, Lewis and his team are looking at launching a series of upmarket Tesco Finest* convenience stores.

Potential for 7% margin

At a recent analyst and investor day, the boss unveiled his new idea and claimed there was potential to achieve a 7% margin – some way higher than the current target of between 3.5-4.0%.

“Tesco Finest as a brand is one of the largest food brands in the country. We have a very high percentage of more upmarket customers,” Lewis said.

"The opportunity to curate that range and bring new things in a more convenient outlet is something that we have tested, is something we're interested in.”

Should we be surprised?

Although a change in direction for Tesco, perhaps it shouldn’t come as too much of a surprise.

Alongside Aldi and Lidl, two of the best-performing ‘big shops’ in recent months have been Waitrose and Fortnum & Mason.

In other words, the most aristocratic and plebeian outlets have each been getting their share of the spoils, while those in the middle have been somewhat caught out.

This might explain why Tesco is keen to roll out its own chain of stores that targets a particular part of the market.

Quick facts: Tesco PLC

Price: 242.4 GBX

LSE:TSCO
Market: LSE
Market Cap: £23.77 billion
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