Tesco’s China plan may put dividend under pressure

But its “memorandum of understanding” with state-owned China Resources Enterprise (CRE) drew a mixed response amid claims it could delay plans to return more cash to shareholders.

Some saw it as a retreat from China, a market Tesco has been trying to crack for almost a decade with little success. Reports suggest the British group could pay CRE several hundred million pounds to obtain a 20 per cent stake in the combined business.

But independent retail analyst Nick Bubb said Tesco is actually increasing its exposure to China with a partner that brings “formidable scale and local access”, but by paying to do so it may have to put plans to raise its dividend on hold. As part of plans to return the company to bottom-line growth, management has pledged to grow the pay-out “broadly in line with underlying earnings”.

Bubb said: “The only figure in the statement is the fact that combined sales will be as much as £10 billion, but the suggestion is that money will change hands.

“In some ways, Tesco is therefore increasing its exposure to China, but its partner brings formidable scale and local access, so it is hard to fault the logic of the move, even if it reads badly for the initial gung-ho expansion into China under previous management.”

But he added: “With the cost of this move in China, and rumours that the exit from the US may cost Tesco more than it had expected, the market may be re-thinking its timescale for Tesco to return cash to shareholders, notwithstanding the good reception to its new-look UK hypermarket plan.”

Earlier this week, Tesco unveiled the first in a new format for its out-of-town superstores, incorporating cafes and restaurants to make them a leisure destination.

CRE operates 2,986 supermarkets across China and Hong Kong through its Vanguard brand, while Tesco has 131 outlets. The joint venture would create a business with about £10bn in sales. Last year, Tesco’s China operations generated sales of £1.43bn.

Asian analysts were less generous in their assessment of Tesco’s move, saying it had joined a growing list of western retailers who had failed to crack the Chinese market.

Lured by the prospect of a rapidly growing middle-class in the world’s second-biggest economy, many foreign firms have waded into China’s retail market only to find they lack local expertise, particularly in building strong relationships with suppliers.

Germany’s Metro said in January it was pulling out of the consumer electronics business in China while Home Depot said last year that it would close all seven of its big-box home improvement stores.

Tesco, which recently announced decisions to exit the US and Japan markets, has been building its independent presence in China for nine years.

Jonathan Jackson, head of equities at Killik & Co, pointed out that Tesco’s deal with CRE is not signed yet .

“If it does go through, I expect it to be in line with the group’s strategy to focus on increasing returns on investment wherever it allocates its capital,” he said.

As such, Jackson believes the deal would ultimately be positive for the dividend, although the success of the UK business is the “key driver”.

The talks comes at a time when Asia’s richest man, Li Ka-shing, is considering the sale of his Hong Kong supermarket business. CRE was seen as a potential bidder for that business, but some bankers said it may now be it too busy. Asda’s US parent Wal-Mart is also said to be circling.