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Tesco strategy under scrutiny as British sales slide worsens

By James Davey and Kate Holton

LONDON (Reuters) - Britain's biggest retailer Tesco recorded its worst quarterly UK sales drop in 40 years, raising questions over boss Phil Clarke's strategy to counter the challenges of a rapidly-changing grocery industry.

British consumers are looking around to save money, trying to waste less by buying little and often in local convenience stores instead of a big weekly shop at large out-of-town stores.

They are turning to fast-growing discounters Aldi [ALDIEI.UL] and Lidl [LIDUK.UL] for basics and Waitrose [JLP.UL] and Marks & Spencer for top end treats. Tesco is caught in the middle and has posted two straight years of profit decline with a third forecast for 2014-15.

With its key measurement of underlying sales at British stores down 3.8 percent in its fiscal first quarter, Clarke is accelerating an investment programme to modernise stores in the 95-year-old group and is cutting prices to try to woo back shoppers and re-build long-term loyalty.

But with rivals Wal-Mart's Asda and Morrisons promising billions of pounds of price cuts and Sainsbury's vowing to remain competitive some analysts think Tesco's prices are still too high.

"The sustained poor and under-performance is most clearly because its prices remain too high," said Shore Capital analyst Clive Black.

"Tesco's customer insight must be drumming up some crazy stuff if it is leading management to adopt its present strategy, which to our minds is clearly not working."

Some believe that with Tesco's UK market share still standing at 29 percent, nearly double its nearest rival, it should reassert its dominance by launching an all-out price war, an outcome that would hit earnings across the sector.

"Clarke's only option now is to get out the big bazooka and blow the competition away," said John Ibbotson, director of the retail consultants Retail Vision.

PLANNING TO STAY

Clarke, who began his 40-year Tesco career aged 14, stacking shelves in a store managed by his father, reiterated he has no intention of quitting. "I'm not going anywhere, I'm going to see through the fundamental reshaping of Tesco," he told reporters.

He is two years into a multi-billion pound turnaround plan for its British business which contributes two-thirds of sales and profit for the group, the world's third-largest retailer after Wal-Mart and Carrefour .

Clarke has invested in store refits, staff, product ranges and online services, and dropped an industry leading profit margin target, but has so far failed to deliver any improvement in underlying sales.

Tesco said sales at UK stores open for longer than a year, excluding fuel and VAT sales tax, fell 3.8 percent in its fiscal first quarter, hurt by the price cuts deflating sales, a reduction in untargeted promotions, disruption from refurbishments and an overall grocery market growing at its slowest pace for over a decade.

Analysts had forecast a decline of 3.5-4.1 percent, after a fall of 3 percent in the previous quarter.

Tesco shares, down 17 percent over the last year, were down 1.2 percent at 1157 GMT, trading close to six-year lows.

"With the group's biggest operating cashflow driver (the UK) still failing to show signs of stabilisation, we remain concerned by the group's leverage structure," said analysts at Jefferies.

Though the first quarter outcome was not as bad as some analysts feared after the release of weak market share data on Tuesday, one Tesco investor called the figures "shocking".

"I find it difficult to see what the strategy actually is. It's difficult to see how things are going to improve. They are trying to be too clever and please everybody but you can't do that," said the shareholder.

"They don't seem to be concerning the Aldis and Lidls at one end or concerning Waitrose at the other. Despite the upbeat spin, sales are still woeful."

IMPROVEMENTS

Clarke told reporters he could not recall a weaker quarterly performance in his career but insisted his strategy was the right one, saying he was pleased with the response of customers to price cuts, the roll-out of a fuel savings scheme for holders of Tesco's loyalty card, reduced home delivery charges and over 100 stores refreshed in the quarter.

“The plan is working ... We’ve cut prices and they’ve brought down our like-for-like sales in the short term but we’re now much more competitive and volumes on the lines we’ve cut are up over 28 percent," he said.

"There’s more to come. Price is an important part of the story but it’s not the only story."

But the CEO again cautioned that like-for-like sales would continue to be negative as price cuts hit sales going through the till and are not offset by volume gains and as 200 more stores are refreshed in the second quarter.

“I see every day the improvements that are coming in the business but I’m not making any promises about sales improvement in the next few quarters,” he said.

Tesco has not just suffered in Britain in recent years. Overseas, failed attempts, instigated by Clarke's predecessor Terry Leahy, to break into the United States and Japan and troubles in China and Europe have proved a distraction.

Tesco said international sales tumbled 8 percent due to currency effects, but rose 0.5 percent at constant currencies, with like-for-like performance in Asia improving compared with the previous quarter despite political turmoil in Thailand.

The firm said last week it had failed to reach a deal with unnamed parties over its struggling business in Turkey.

Uncertainty also hangs over Tesco's plans in India after the election of the Bhartiya Janata Party, which has said it will not allow foreign direct investment in multi-brand retail. Tesco said on Tuesday it had completed the establishment of a joint venture with India's Tata.

(Additional reporting by Chris Vellacott and Emma Thomasson; editing by Anna Willard)

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