Tesco shocks the market

FBN's Liz MacDonald on Tesco's profit warnings.

Tesco Cuts Profit Outlook, Suspends Executives, Probes Accounting Error

Politics Reuters

Tesco cut its profit forecast for the third time in two months on Monday and suspended four members of staff after finding a major fault in its accounts, dealing another blow to the reputation of the world's third biggest retailer.

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Just three weeks after Dave Lewis started as its new chief executive, Tesco's shares fell up to 12 percent after the firm said it had called in its lawyers as well as new accountants to investigate an error in its UK food business that forced it to cut its first-half profit outlook by 250 million pounds ($408.50 million).

A profit warning on Aug. 29 had overstated expected first half profit by 23 percent, it said.

Shares in Tesco's quoted UK rivals Sainsbury's and Morrisons both fell over 2 percent.

Tesco's error - caused by the early booking of revenue and delayed recognition of costs - had been discovered during preparation for its forthcoming interim results, Tesco said.

Their publication has now been pushed back from Oct.1 to Oct 23 by Lewis, who said on Monday a "commercial manager" had notified Tesco's legal team of the issue on Friday.

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"This is something completely out of the ordinary. Never mind the (Tesco) finance function, the auditors didn't catch it," said chairman Richard Broadbent, who told reporters he would not be resigning.

Tesco's current auditor PwC [PWC.UL] which has worked for it since 1983, declined to comment.

Tesco, which ranks behind France's Carrefour and U.S. giant Wal-Mart in annual sales, is currently without a full time group finance director, with Lewis, who succeeded the ousted Phil Clarke as CEO on Sept. 1, its only executive director.

Alan Stewart, formerly of Marks & Spencer was named as Tesco's new chief financial officer on July 10 but does not start until Dec. 1. Laurie McIlwee quit as Tesco CFO in April and although his official leaving date is Oct. 3 he has not been working full time.

STEP ASIDE

Lewis said four Tesco employees had been "asked to step aside" while the investigation proceeded but had not been disciplined. He said it was too soon to say whether it was a case of fraud.

The BBC and Sky News reported that Chris Bush, the managing director of Tesco's UK business, was one of the four.

Lewis declined to comment on Bush, a Tesco veteran of 32-years, specifically but said Robin Terrell, the firm's multi-channel director, had stepped in to lead the UK business, Bush's role

Sky also reported that Carl Rogberg, Tesco's UK finance director, was one of the four staff members. Tesco declined to comment.

"We have uncovered a serious issue and have responded accordingly. The chairman and I have acted quickly to establish a comprehensive independent investigation," said Lewis, adding he would take "decisive action" when the results of the investigation were known.

Tesco was working to establish the extent of the issues and the impact they might have on its full-year profit.

"The early indication is that (250 million pounds) number is more to do with timing in the first half/second half than anything else, but I can’t be definitive until I’ve finished a full investigation," said Lewis.

Niall Dineen, a portfolio manager at AGF International Advisors, and shareholder in Tesco, asked: "Is this a real problem or kitchen sinking?"

Geir Lode, head of Hermes Global Equities, said the presence of some top flight investors on the shareholder register may have led other shareholders to be overly complacent. "Some investors might have bought the shares having a perception of quality based on Warren Buffet’s ownership, but in this case the free cash flows and business stability are not there," he said.

Tesco has appointed a new adviser Deloitte [DLTE.UL] to undertake an independent and comprehensive review of the issues, working closely with Freshfields, its external legal advisers.

UK business secretary Vince Cable said the Financial Reporting Council (FRC), the body that oversees corporate behavior, could be called in to investigate Tesco if it transpires that "serious malpractice" had taken place.

The grocer said last month it expected trading profit for the six months ending Aug. 23 to be in the region of 1.1 billion pounds.

The new forecast of 850 million pounds means group trading profit has nearly halved from the 1.6 billion pounds it recorded in the comparable period last year.

With a market valuation of 18.8 billion pounds and over 500,000 employees, Tesco had been the darling of the sector during two decades of uninterrupted earnings growth.

Under Clarke, Tesco issued three profit warnings in two and a half years as it lost UK market share to fast-growing German discounters Aldi [ALDIEI.UL] and Lidl [LIDUK.UL] as well as upmarket rivals Waitrose [JLP.UL] and Marks & Spencer, sending its share price to decade-lows.

OVERSTATEMENT

Tesco explained in a short statement to the stock exchange on Monday that it had got its numbers wrong.

"Tesco has identified an overstatement of its expected profit for the half year, principally due to the accelerated recognition of commercial income and delayed accrual of costs," it announced, adding some of the impact included "in-year timing differences".

Accrual accounting requires that a company record its payments as soon as it places an order with its suppliers rather than when it subsequently pays for it.

"Such an announcement is not the stuff of a well operated FTSE-100 organization," said Shore Capital analyst Clive Black.

"This development may raise, indeed must raise, much more fundamental questions over the chairman's position and the nature, composition and extent of the board."

Broadbent said he wanted to stay. "Shareholders I’m sure will decide...whether I’m part of the solution or part of the problem. But my intention is to continue being part of the solution."

Bernstein analyst Bruno Monteyne said the bringing in of Freshfields "implies there is potential foul play, beyond simple account stretching."

By 8:08 a.m. EDT on Monday the stock was down 8.4 percent to 210.2 pence, while the market also marked its credit wider.

(By James Davey and Kate Holton; Additional reporting by Clara Ferreira Marques, Nishant Kumar and Simon Jessop; editing by Sophie Walker and Janet McBride)