UK supermarket chain Tesco has three issues, but only customer relations matter

Investors, regulators, customers – everyone wants a piece of Tesco. The UK supermarket chain has come under fire from two big shareholders over what they see as a distracting, expensive takeover of wholesaler Booker Group. A financial regulator has used Tesco to experiment with compensating victims of market abuse. And customers just want ever- lower prices, as always. This last challenge is the one that could really knock things off course.

Schroder Investment Management and Artisan Partners have taken issue with Tesco’s 3.7 billion pound ($ 4.6 billion) purchase of Booker. The cashand- shares bid should cover its cost of capital within two years – but only if the full cost savings Tesco has forecast come through. Assume no synergies, and the return on investment is less than 5 percent, according to a Breakingviews calculation. Focus too much on extracting those savings and Tesco’s so- far- so- good turnaround might suffer.

The regulator, too, is on solid footing. Britain’s Financial Conduct Authority ( FCA) wants Tesco to compensate investors who bought shares and bonds before an accounting scandal came to light in September 2014. This is a new concept for the FCA, which has done its own number- crunching to work out what the shares should have been worth when investors were buying. It relies on judgment, but the principles are sound.

So how can Tesco face its detractors? The regulatory problem is already history. Only two of the grocer’s current 12- person board were there when the accounting fiddles took place, and Chief Executive Dave Lewis’ hands are clean. Shareholders peeved over the Booker deal will be harder to please, but then they will get to vote on it in due course. The best thing Tesco can do until then is stick to its knitting, and not miss analyst forecasts of a 2.3 percent operating margin when it reports full- year earnings on April 12.

The third issue – dealing with the impact of parsimonious customers – is thornier. Grocery inflation has turned positive after more than two years of being negative, and a weaker sterling means much of the gains will go to Tesco’s suppliers. The pressure to sacrifice profit by cutting prices, including any savings derived from buying Booker, will intensify. Schroders and Artisan may be right to worry that the deal won’t live up to its promise, but Tesco has bigger problems in store.