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City focus: Leahy keeps on truckin'

Britain's largest retailer rang up a record £2.55 billion ($5.1 billion)in pre-tax profits last year - a rise of 13.2% - and doubled the amount of cash it plans to return to shareholders to £3 billion.

There seems to be no stopping the Tesco juggernaut. Even the well publicized backlash against the dominance of Tesco, which currently accounts for £1 in every £3 spent on food, has done little to stop its tills from ringing. Underlying sales rose 5.6% in the UK, fuelled by strong demand for posh nosh and organic food ranges as well as a surge in sales of clothing and toiletries. And there seems little sign of a slowdown, according to chief executive Sir Terry Leahy, who has been at the helm for a decade now.

While the headline figures point to another faultless performance, City analysts reckon there is some cause for concern. Asda, Sainsbury and Morrison are simultaneously on the revival trail and have become formidable competitors. There are also signs that inflation, caused by higher energy costs and a rise in food prices is starting to erode Tesco’s profit margins. This could hamper growth within its core grocery business, which accounts for the bulk of Tesco’s sales. James Collins, a retail analyst at Deutsche Bank, said he was “disappointed” by the fact that UK operating margins were flat for the year.

Meanwhile Tesco’s overseas business, which posted a rise of 2% in underlying revenues, put in a lackluster performance. Hungary, Thailand and South Korea - three key markets for Tesco - are all suffering from economic or political turmoil and could become a drag on the group. Even Leahy admits the retail environment isn’t getting any easier. But he insists: “We heve managed to cope with the headwind coming from recovering competitors and rising costs. “ The City clearly thinks Tesco is worth holding onto. Shares in the chain rose 6% to 4613/4% as investors cheered the results. Analysts welcomed the supermarket group’s actions on the property front.

Tesco plans to increase the amount raised from a stores sell-off from £5 billion to around £8 billion, of which £3 billion will be returned to shareholders. Although the sweetener will do little to boost the company’s share price, it shows that Tesco is looking at ways of extracting value from its lucrative stores estate for the benefit of investors. The company’s stores are valued at £17 billion on the books, but Tesco reckons they are in fact worth £28 billion. The move comes hot on the heels of activist action against Sainsbury, which is being urged to do more with its property assets after the collapse of takeover talks with private equity.

Leahy is confident Tesco has enough momentum to continue growing. It will open 584 new shops this year, of which 142 will be in the UK, bringing the total to more than 3,800. It also has ambitious plans to crack the US market and is looking to open stores in India. Meanwhile the non-food business - which sells everything from clothing to tellies - shows no signs of slowing down. Its underlying sales surged 11.6% to £7.6 billion in the year. Including international, non-food sales were £10.4 billion, representing 25% of the company’s turnover. Critics have urged competition watchdogs currently investigating the supermarket industry to put a stop to so-called Tescopoly. Nick Goulding, chief executive of the Forum of Private Business, said: “The Competition Commission must answer the questions of whether King Kong Tesco is playing by the rules.”

The Commission will publish its report later this year and many believe the grocer could be forced to sell off some of its stores. Until then, the Tesco HGV will continue to be king of the road. Tesco’s trip to the US comes at a price. The costs of opening its chain of Fresh & Easy convenience stores on the west coast of America are set to triple to £65 million from estimates of around £20 million. Boss Sir Terry Leahy reckons the extra investment is worth it. He said the US could accommodate a business as big as Tesco is in the UK. “If we are successful, we can become very large,” he said. The first stores will open later this year in Los Angeles, Phoenix, Las Vegas and San Diego. (