Tesco is the UK’s largest retailer, with a turnover of £43 billion last year and 270,000 employees worldwide. Tesco operates in 12 different countries and has recently announced its expansion into the US. We speak to Nick Mourant about managing working capital in the retail industry and the £1.2 billion bond deal announced by Tesco last year.

What is your role at Tesco?

The group treasurer role at Tesco covers the traditional areas of responsibility: liquidity management, funding, foreign exchange and credit risk. Tesco has a market capitalisation of about £34 billion and a debt of circa £4.5 billion, and it’s my responsibility to deliver the interest numbers and manage the foreign exchange risk. My role also covers areas that are slightly wider than the normal treasurer role in that because I have responsibility for relationships with banks and financial institutions, I also get involved in how we run our retail bank operation. Tesco owns a retail financial services operation called Tesco Personal Finance (TPF) which provides banking services to our customers, such as motor insurance, credit cards, loans, and savings. I am involved with TPF in terms of how we structure some of that – primarily from a Tesco Stores viewpoint, so from our retailer’s viewpoint – dealing with TPF as we would with any banking partner.

I also work with my store and IT colleagues on how we handle tendered cash, cheque and card payments received through the tills, from the point at which they go through the till to the point at which we get value. For a retailer, how we process the payments we receive is an important issue and I therefore spend a significant amount of time on operational issues.

So my role ranges from a traditional corporate treasury role, the day-to-day management of cash, through to the strategic issues around how we structure our balance sheet and what level of funding we are taking out of the capital debt markets versus our equity. We try to manage our overall cost of funding down to the optimum point on our WACC (weighted average cost of capital), which will involve discussions around the level of equity issuance and debt issuance in the group. In May 2006, we said that we were looking to raise circa £5 billion from the sale and leaseback of stores over the next five years, and that we would be using the funds raised from that programme primarily to buy in shares of circa £1.5 billion over the next five years – and also to invest into new avenues of growth.

How is the treasury structured?

I have three teams directly reporting to me, with the first one covering the relationship between the Tesco group and its operating subsidiaries – whether that’s in the UK or Korea or Thailand. The relationship role is covered by Tesco’s International Treasurers, who report as part of this team. One looks primarily after our Asian subsidiaries and one looks after our European subsidiaries. The second team is a middle office one looking after property funding and accounting. The third team is primarily a dealing role, looking after capital markets issuance, cash management and foreign exchange. In total there are 12 UK employees in Tesco Treasury and we also run a small dealing operation out of Hong Kong for our Asian subsidiaries, which is primarily foreign exchange and cash management.

What operations does Tesco have in China?

Tesco has about 50+ hypermarkets in China. We entered China three years ago with a 50:50 joint venture with Ting Hsin. Just prior to Christmas, we announced the buy out of our JV partner’s stake to move our stake up to 90% ownership of that Chinese venture, with 10% still held by our JV partner. The driver there was to enable Tesco to push on a little faster with expansion in China but also to help us manage that0 business. So by leaving our JV partner with a significant minority interest, effectively we retained their involvement in the business but took more control over the speed with which we are developing.

We opened our first Tesco branded store in China earlier this year. The stores in China trade under the Hymall name, which was the existing trading name in China. Following the purchase of the JV interest we have now branded our first store as Tesco.

What particular challenges do you face in China from a treasury point of view?

The visibility over cash has been difficult. The local tax legislation is such that each store runs its own bank accounts. It’s difficult to organise set-off and pooling arrangements between cash surplus stores and those in deficit. Also, from a tax perspective it is difficult to organise tax grouping between the stores.

We are obviously moving to entrusted loan arrangements so that we can net surplus sites with deficit sites. We’re also trying to move our tax arrangements such that profitable stores are effectively able to take the losses of unprofitable sites. The comment I would make is that the legislation in China is not necessarily clear cut and also that there are a lot of differences in interpretation between the regional government and state government.

What challenges have you faced in the last year?

The announcement on the sale and leaseback programme gave clarity to both our shareholders and bondholders of our intentions on our freehold/leasehold mix. It also gave an indication of how valuable our freehold properties were and gave the stock market some comfort that we wouldn’t be looking to issue equity.

We’ve also had the introduction of new accounting standards, particularly IAS 39 and IAS 32. At the same time the treasury has spent a significant amount of time ensuring that the group’s structure is appropriate for our operations and making sure that how we hold our overseas investments is efficient, from a funding, tax and financing viewpoint.

How important is working capital management in your industry?

Retail is traditionally run with negative working capital, so we’re taking payment from our customers over the tills before we’ve paid our suppliers. As a UK food retailer we run with significantly less creditor days than our international competitors, such as Carrefour and Ahold, who pay their suppliers significantly later than Tesco does. Tesco pays our trade creditors in 32-35 days; our competitors would be paying them in 60 days plus, which puts us at a disadvantage in terms of our funding arrangements. Having said that, Tesco is pretty good at our stock management, and the number of days’ stock that we have in our supply chain compensates for our early payment terms. So if you look at our net negative working capital we are probably competitive with Carrefour and Ahold.

I think the thing that’s become clear to us as we’ve moved more into non-food and also expanded internationally is that UK food retailers have significantly faster payment terms than our international competitors. These terms of trade and payment terms have developed over time, and if you started with a blank sheet of paper, you’d query whether the UK has necessarily got its funding correct.

The prime focus of working capital management is making sure that the financial supply chain is efficient, and that managing stock within the business is efficient – those are the two big drivers. We look to manage to negative working capital of about 15 days and we have 34 days’ trade creditors and 16 days’ stock within the business. That varies according to which country we’re operating in. Korea and Thailand potentially have longer payment terms and also more stock days depending on the mix of food and non-food.

Why did Tesco raise funds through its bond deal in March last year?

This was a £1.2 – 1.3 billion transaction, the prime aim of which was to take a view on where absolute rates were and also to lock away some funding for 36/42 years. There were several parts to the transaction:

• There was a £175m, 1.98% issue of index linked notes to 2036, which is effectively an RPI based transaction. As a retailer, there is a strong correlation between how the business performs and RPI, so taking some hedge against RPI through the capital markets makes sense for us.
• There was also a £300m, 4.875% issue to 2042, and a £350m 5% issue to 2023 – both of those issues have been left as fixed rate. Really those sort of long dated maturities are akin to quasi equity.
• We also have a €500m 2011 issue.

The reason for having both euro and sterling issues was to maintain some competitive tension between the euro markets and the sterling institutional market.

How was this arranged?

There were five lead managers: BNP Paribas, Citigroup, Deutsche Bank, HSBC and RBS. It’s unusual to have a transaction with as many lead managers as that, but that is the Tesco inner core group and we wanted to make sure that we spread our capital markets business amongst them. We were pleased with the issue, which was about 1.5 times over-subscribed.

There was a certain amount of pushback from some of the European investors in the short-dated euro issue in that we didn’t give a ratings trigger clause. In the event of a takeover of Tesco and a ratings downgrade below investment grade, such a clause would allow bondholders to put those bonds back to Tesco at par. In my view it’s not appropriate to give a ratings trigger for issues less than ten years.

How do you manage your banking relationships?

As I mentioned before, we have five banks in our inner core. We have a wider banking relationship group of 15 banks. In July 2005, we put together a £1.75 billion committed seven year facility through to 2012, and that was priced at such a level that the banks coming into it weren’t covering their cost of capital, so there was a commitment fee of four basis points and a drawn fee of 15 basis points. Because of the tight pricing in this facility a number of our existing banks did not come into the facility and I used this pricing as a way of cutting down my banking group.

We manage our banking group using a quadrant analysis, whereby we measure the return on capital to our banking partners on any piece of work that we do with them. So for example one quadrant would be high margin, low capital intensity business; while another quadrant would be high capital intensity, low margin business. We effectively try to step into the shoes of our banking partners to assess the profitability to them, whether it’s in terms of foreign exchange, lending business, structured transactions or capital markets issuance, to get a feel for the share of wallet that the banks are taking. The intention is that the top five inner core banks take approximately a 75% share of wallet.

We also go through an exercise with our core group, whereby we show them the 20 or so projects that we’re working on, then invite them to tender on three or four pieces of that business. That way it’s clear to the relationship group what we’re working on, but also what else they should be concentrating their efforts on with Tesco.

What is the impact on the treasury of your expansion into the US?

We announced in January 2006 that we were looking to enter the US in the West Coast on greenfield sites, so effectively an organic programme. We said at the time that we were looking to spend approximately £250m per annum in the US on setting up a chain of convenience store locations and those first stores are due to open in the third quarter of this year. They will trade under the trade name Fresh and Easy. The operation is based on neighbourhood stores similar to our Express format.

Capital spending in Tesco is approximately £3 billion a year and this is an additional £250m of capital spend. The US is another market amongst the 12 we’re currently in. From a treasury viewpoint we’ve had to go through a tender for cash and banking and structuring of the operations. This move will represent another stream of funding requirement for us, and also another country alongside those that we’re already operating in.