Martin Flanagan: Wheels come off at Tesco

Tesco is facing regulatory and political scrutiny, a possible probe into suspicions of cooking the books, consumer confusion and spiralling investor anger. Picture: Phil Wilkinson

Now the ex-Unilever man knows that, apart from crafting strategic changes to fend off discounters Aldi and Lidl, Tesco is facing regulatory and political scrutiny, a possible probe into suspicions of “cooking the books”, consumer confusion and spiralling investor anger.

The bombshell catalyst was Monday’s announcement that even after a profit warning last month, Tesco had still inflated its first-half profits forecast by £250 million. “It’s amazing how things have gone so far wrong at Tesco,” Paul Mumford, fund manager with Cavendish Asset Management, which owns 550,000 shares in the group, says. “And the problem is, if you have one accounting problem here are there other ones elsewhere?

“After doing great things for many years, all the wheels now seem to be falling off at the company. You just don’t expect an accounting scandal at a business that size.”

Dave Lewis (below) must try to salvage Tescos reputation after it inflated its first-half profits forecast by £250m. Photograph: Phil Wilkinson

Lewis has set in train the retailer’s investigation into how the profits mis-statement came about. It will be led by lawyers at Freshfields and outside accountant Deloitte, with Tesco’s regular auditor, PriceWaterhouseCoopers, embarrassingly sidelined.

But, as that inquiry gets under way, reputational doubts around Tesco now have a momentum of their own. The Financial Reporting Council, which regulators auditors, is monitoring the situation, as is the investor protection regulator, the Financial Conduct Authority, and the Serious Fraud Office.

Tesco suspended four UK executives after the discovery of the £250m profits shortfall by an internal whistle-blower in the run-up to the interim results – which have now been delayed from early next month to 23 October. Past and present Tesco directors have been warned they may be hauled before MPs to explain the fiasco, which followed a string of profits warnings before Clarke left earlier than planned at the end of August and Lewis parachuted in.

Adrian Bailey, chairman of the House of Commons business select committee, said it was “unbelievable” a business the size of Tesco could get into such a mess. He said any parliamentary probe could be extended to the wider UK grocery industry, looking at “what is going on in the retail industry and in the relationship with the suppliers to see if the issues we came across two years ago are still there”.

Tesco has said the profits overstatement related to income it receives from suppliers, which it booked early, while delaying booking associated costs, thereby flattering profits.

Exacerbating the controversy, it came to light last Thursday that outgoing group finance director Laurie McIllwee had not had any input to any financial matters since he resigned on 4 April with a £1m “golden goodbye”.At the time, Tesco said McIllwee had “agreed to remain in his role to ensure a smooth handover to his successor” until his formal leaving date in October.

One headhunter said: “This will fuel investor scepticism about these so-called handover periods between incoming and outgoing chief executives, whether it is in the banks, supermarkets or whatever.

“Being cynical, and looking at what has happened at Tesco, in particular, you could see these handover periods as completely artificial and just a way to sweeten investors a little about the size of the payoffs.”

Clarke was initially due to work with Lewis until the end of this year in return for his own multi-million pound payoff deal before the August profit warning led to his immediate defenestration.

Not the least of the City’s concerns is that Tesco’s management in transition – former M&S finance director Alan Stewart has now joined earlier than agreed because of the mounting problems – will be snarled up in financial issues going into the final “golden quarter” of the retailing trading year.

One analyst said: “Retailers, to one extent or another, earn a high proportion of their revenues in the run-up to Christmas.

“Tesco would have been wanting to be preparing for their Christmas campaign. Their rivals will be. Instead, Tesco will be fire-fighting on the financial and regulatory fronts.”

The reputational damage is debilitating for a company that under Sir Terry Leahy’s leadership in the decade from the mid-1990s seemed to be all-conquering, vanquishing rivals at home and extending abroad from central and eastern Europe to Asia.

The shares were under pressure for much of last week and ratings agency Standard & Poor’s has warned it might downgrade the retailer’s credit ratings.

By some estimates Tesco has lost one million shoppers a week in recent years as parts of Leahy’s success story have unravelled, most notably the pulling of the plug by Clarke on Leahy’s move into America with the never profitable Fresh & Easy brand, at the cost of a £1 billion writedown.

When the latest furore about the financial integrity of Tesco dies down, many believe the mainspring of a new strategy from Lewis will be to radically ramp up price promotions in a British business that contributes 70 per cent of group products, while scaling back on the group’s global and diversified operations.

Some believe this could mean jettisoning Tesco Bank, where the group took full control last year of its previous joint venture with Royal Bank of Scotland, and also the garden centre expansion that Leahy pioneered. Focus is likely to be the new buzzword.

But it has been a chastening week, and Lewis knows a wider corporate reputation has to be salvaged for that more focused strategy to bear fruit. His own reputation is now in the eye of the storm at the British household name.

Profile: In need of a little help

March 2011: 40-year Tesco staffer Phil Clarke succeeds Sir Terry Leahy as chief executive

January 2012: Tesco shocks market with first profit warning in a generation. Soon after Clarke announces £1bn plan for turnaround. Involves major store refit programme, additions such as Harris + Hoole coffee shops and Giraffe restaurants, and £200m of price promotions.

April 2014: Finance director Laurie Mcllwee annouces he is to resign later in year. He will get a £1m payoff.

June 2014: Tesco reports biggest decline in sales in two decades as discounters take market share. Chairman Sir Richard Broadbent backs Clarke at often stormy AGM as little sign of turnaround working.

21 July: Clarke (below) quits after another profit warning with near-£10m payoff.

29 August: Tesco slashes interim divi 75 per cent and announces another profit warning. Says new boss Dave Lewis, from Unilever, will now start 1 September rather than October, and Clarke will leave immediately rather than in January 2015.

22 September: Tesco suspends four UK executives while it investigates £250m overstatement of interim profits guidance given only three weeks earlier.

25 September: chairman of business select committee says past and present executives could be quizzed by MPs on “unbelievable” accounting mistake at company that size.