Identify economic characteristics and competitive dynamics in the industry Identify the main strategies of the two companies Assess the quality of the financial

9 – 1 1 3 – 0 4 0

S E P T E M B E R 1 8 , 2 0 1 2

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Professor Suraj Srinivasan and Research Associate Penelope Rossano prepared this case. This case was developed from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of pri mary data, or illustrations of effective or ineffective management. Copyright © 2012 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

S U R A J S R I N I V A S A N

P E N E L O P E R O S S A N O

Ahold versus Tesco – Analyzing Performance

Introduction

At the completion of her MBA program, Mary King was hired as a European Equity Analyst by

Alpha Plus Asset Management.a In her first big investment decision, she was tasked with advising the portfolio manager about a potential investment in the retail sector. Mary had whittled her choice to two retailers – Koninklijke Ahold (Ahold), a retailer headquartered in the Netherlands, and Tesco PLC (Tesco), a UK-headquartered retailer. Since this was to be her first recommendation, Mary knew that she would be acutely judged on the quality of her analysis.

Mary analyzed the business models of Ahold and Tesco by reviewing their history, geographic reach, and product and service offerings. She was particularly interested in the historical and current business strategies of the companies and how key financial results were affected by these strategies. Based on her review, Mary summarized the history, business strategy, recent performance, and future goals for each company.

Company Fundamentals

Koninklijke Ahold N.V. (Ahold)

History Ahold’s roots stemmed from the founding of a Dutch grocery store, Albert Heijn, in 1887 by its namesake Albert Heijn and his wife.1 It was a family business that grew in the following decades, under the leadership of Heijn’s grandsons to become one of the most important companies

in food retail in the Netherlands.2 Notable innovations included bringing self-service grocery shopping to the Netherlands,3 the development of own-brand food items (private label), and ready-

to-eat meals.4 Albert Heijn introduced non-food items, including liquor and health and beauty items, into its product lines in the 1970s5 and ventured into international expansion, first in Spain and then

the United States.6 Expansion continued and by the 1990s its international reach touched Latin America, Eastern Europe, and Asia.7 Expansion slowed and the business eventually contracted during the 2000s amidst accounting irregularities and management changes. In 2006, Ahold launched

a Names are for illustrative purposes only.

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113-040 Ahold versus Tesco – Analyzing Performance

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a new strategic plan for profitable growth by focusing on strengthening its competitive position in its European and U.S. markets.8 It divested non-strategic assets and built its brands by improving

operations, lowering some prices, and more tightly managing costs.9

Business Structure and Performance Ahold sold food, grocery, and drug products, primarily in its 3008 retail stores in the Netherlands and the United States and employed over 218,000

full time employees.10 In addition to Albert Heijn, Ahold operated other leading brands including Etos drug stores, Gall & Gall liquors, and albert.nl in the Netherlands and Giant Carlisle, Stop &

Shop, Peapod, and Giant Landover in the U.S.11 It operated supermarkets ranging in size from compact (400 square meters) to superstores (8,400 square meters), which sold food and non-food

products.12 It also operated convenience stores, which were smaller stores (40 – 200 square meters) that were located in places of convenience for customers such as train stations, smaller streets, and at

gas stations.13 Finally, Ahold reached its customers via online channels. It ranked as the largest online retailer in the U.S. with the Peapod brand and in the Netherlands with the albert.nl brand.14

For the five years prior to 2011, Ahold’s strategy focused on an effort to lower its cost base, which allowed the company to invest in lowering certain price points, creating value, and being able to offer value added products and service offered to customers.15 In recent years Ahold had achieved its stated goal of sustainable net sales growth of five percent and an underlying operating margin of five percent.16 Ahold had achieved revenues of more than EUR 30 billion in sales, operating income of EUR 1.3 billion, net income of EUR 1 billion, and a market capitalization of EUR 11.188 billion (see Exhibits 1 and 2 for company financials).17 Ahold’s paid out dividend of 40 to 50 percent of adjusted

income from continuing operations, which equated to EUR 0.40 per share in 2011.18

Ahold’s business was geographically concentrated. As of FY 2011, 94% of total net sales were driven by operations in the Netherlands and the U.S. The business had grown faster in the most

recent year, at 6.6% year over year versus 4.2% in the Netherlands.19 Despite this, margins were higher in the Netherlands with 6.3% vs. 4.8% overall.20 Ahold had improved margins by strictly

controlling costs and the cost cutting program was planned to continue through 2014.21

In 2011, Ahold revised its strategic plan to focus on growth in what it called its “Reshaping Retail”

strategy.22 The strategy included three pillars to support growth – increasing customer loyalty, broadening Ahold’s offering, expanding geographic reach – and three pillars to enable growth –

simplicity, responsible retailing, and a focus on people performance.23 Goals of Ahold’s growth strategy included new customer loyalty initiatives, increased online sales, opening of new stores, and

increased penetration of own brands.24 With the strategy, Ahold aimed to save EUR 350 million in costs over three years and further increase its dividend pay-out ratio.25 Broader company goals were aimed at helping to improve the communities in which it operated and the lives of its customers by being a responsible retailer and by helping people to live healthier lives and reduce their negative impact on the environment.26

Tesco

History Similar to Ahold, Tesco’s history also reached back almost a century. It had its roots in a market stalls owned and run by Jack Cohen as early as 1919 London’s East End.27 Over time, Cohen

developed his market stalls into a successful grocery trading business.28 The first store opened in 1929 in Burnt Oak, Middlesex and in 1932 Tesco Stores Limited was founded.29 By 1939, there were over 100 Tesco stores across the United Kingdom – many of which were based on a self-service grocery store concept which Cohen had learned from the U.S.30 As he grew a successful grocery trading

business, Cohen’s business motto was "pile it high and sell it cheap.”31

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Ahold versus Tesco – Analyzing Performance 113-040

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Tesco made a concerted effort to expand its footprint internationally beginning in the mid 1990s.32 Its international reach steadily spread across Europe, the U.S., and Asia over the following decades. Tesco also grew its business by expanding its product lines into non food items such as electronics, clothing, music (CDs and downloads), internet services and software, telecom services, and financial services.33

Business structure and Performance As a result of its history, Tesco was not only geographically diverse but had also expanded its product and service offerings. It operated a range of bricks and mortar outlets. Tesco Extra stores, typically set in out-of-town locations, were the largest hypermarkets and stocked all product ranges – food and non-foodb. Tesco Metro stores were smaller

than Express stores and were typically located in city centers.34 Superstores were large supermarkets and stocked groceries and a smaller range of non-food items than Extra stores.35 Tesco Express stores, similar to a convenience store, were located in neighborhoods and residential areas. Product lines in these stores focused on essentials and higher margin products.36 One Stop stores were the smallest

type of grocery stores and were also positioned as a convenience store but in more limited locations.37 In addition to physical products and food, Tesco also offered its customers services, which ranged from financial products, e.g., banking, mortgage, and insurance products, to lifestyle offerings such

as diet tools.38 Tesco offered many customers the opportunity to shop via the internet with groceries and other items delivered to the home. 39 In the stores, Tesco leveraged advanced technology such as

self-service check outs and cameras in its stores to manage customer flow and improve efficiency.40

In FY 2011, with its 6,234 outlets and 519,671 employees, Tesco delivered group sales of GBP 64.5 billion, with growth of 7.4% over the previous year, and group operating profit of GBP of 3.9 billion with pre-tax growth of 5.3% (see Exhibits 3 and 4 for company financials). Financial results varied in different markets and products. The U.K. market generated GBP 42.8 billion in sales, which

represented 66% of group sales,c and GBP 2.5 billion in operating profit (down 1% year on year). A challenging economic environment in the U.K. in the years prior resulted in lower revenue growth

than the rest of Europe with GBP 9.9 billion in sales (15% of group) with 7.3% growth41 and operating profit of GBP 529 million. Asian market results were stronger than for the group. Revenues generated from the Asian region (GBP 10.8 billion) accounted for 17% of the group total and operating profits of GBP accounted for 20% of the group total. Operating profits generated from the Asian businesses were the strongest of all at 21.8%. Despite only contributing 1% to group sales, the U.S. showed the strongest revenue growth with 27.3% but generated an operating loss of GBP 153 million. The banking operations of Tesco also suffered from the challenging economic environment, particularly in the U.K. Despite growth of 13.6%, revenues were only GBP 1 billion (on top of group sales) and operating profits shrunk by 36.4% and generated GBP 168 million (4% of the total). Tesco continued a

long record of dividend growth (up 2.1%) to 14.76 pence.42

Tesco’s strategic objectives introduced in 2010 focused on its U.K. business by making improvements in its service operations. It also expanded and targeted offers to customers, lowered prices, and continued development of a strong management team.43 Tesco’s overall goals for the future were to continue to serve its customers with value-added products and services while also creating jobs, and delivering strong performance for its shareholders.44

b Non-food items included clothing, electronics, books, DVDs, CDs, gifts, jewelry, sports, home and furnishings, gardening, etc. products. c Calculated on a constant tax rate basis.

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113-040 Ahold versus Tesco – Analyzing Performance

4

Analyzing Performance

While Mary had found her brief assessment of the companies’ histories and current strategies relatively straightforward to perform, she struggled with her performance analysis. The companies had performed similar to each other on the basis of their Return on Equity (ROE) over the past three years ranging from 16 percent to 19 percent. However, their stock performance had diverged (see Exhibit 5). Between January 1, 2008 and January 1, 2012, Ahold stock had just about broken even for investors while Tesco had lost more than 30 percent (including dividend returns in both cases). Mary had learned in business school that the DuPont Decomposition analysis was a good tool to assess performance so she used the framework, using company financials (see Exhibits 1-4), to analyze Ahold and Tesco (see Exhibit 6). The traditional DuPont Decomposition approach separated a company’s Return on Equity into three factors: (1) the margins the company was making relative to sales, (2) how profitably a company employed its assets to generate sales, and (3) how big the firm’s asset base was relative to shareholders’ equity in the firm. Based on her DuPont analysis, Mary noted that Tesco had generated higher margins than Ahold, but had lower asset turnover ratios.

Mary wondered what drove the differences in stock performance given the similarity of the ROE numbers. She noted that Ahold held about 2.4 billion Euros in cash and equivalents, which amounted to 16 percent of its total assets compared to Tesco which held only 2.3 billion GBP on a significantly larger asset base of GBP 50 billion or 5 percent of total assets. Ahold had not discussed why it was holding so much cash. Mary wondered how to take into account a company’s cash position while assessing its performance?

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Ahold versus Tesco – Analyzing Performance 113-040

5

Exhibit 1 Ahold Income Statement

Income Statement

(millions of Euro) FY2008 FY2009 FY2010 FY2011

Total revenues

Cost of goods sold

Selling expense

Total expenses

Gross profit

General and administrative expense total

Operating income

Interest expense

Interest and investment income

Net interest expense

Income/(loss) from affiliates

Currency exchange gain (loss)

Other non-operating income (expense)

Earnings before taxes excl. unusual items

Restructuring charges

Asset writedown

Legal settlements

Other unusual items

Earnings before taxes including unusual items

Income tax expense

Earnings from continuing operations

Earnings of discontinued operations

Extraordinary items and accounting change

Net income to company

Minority interest in earnings

Net income

25,648

18,777

4,924

23,701

1,947

696

1,251

(343)

110

(233)

124

87

(67)

1,162

(46)

(3)

–

–

1,113

226

887

195

–

1,802

(5)

1,077

27,925

20,338

5,488

25,826

2,099

740

1,359

(316)

27

(289)

106

(25)

38

1,189

(23)

(39)

–

(7)

1,120

148

972

(78)

–

894

–

894

29,530

21,610

5,714

27,324

2,206

816

1,390

(288)

18

(270)

57

3

8

1,188

(24)

(30)

–

–

1,134

271

863

(10)

–

853

–

853

30,271

22,350

5,652

28,002

2,269

882

1,387

(245)

20

(225)

141

(7)

8

1,304

(15)

(25)

(92)

–

1,172

140

1,032

(15)

–

1,017

–

1,017

Source: Capital IQ, accessed August 2012.

Dates of Filings: December 28, 2008, January 3, 2010, January 2, 2011, and January 1, 2012.

For the exclusive use of R. Lee, 2022.

This document is authorized for use only by Rebekah Lee in BU 650 Summer 2022 taught by Jordan Rippy, Johns Hopkins University from May 2022 to Nov 2022.

113-040 Ahold versus Tesco – Analyzing Performance

6

Exhibit 2 Ahold Balance Sheet

Balance Sheet (millions of Euro) FY2008 FY2009 FY2010 FY2011

ASSETS

Cash and equivalents

Short Term investments

Total cash and ST investments

Accounts receivable

Other receivables

Notes receivable

Total receivables

Inventory

Other current assets

Total current assets

Gross property, plant and equip.

Accumulated depreciation

Net property, plant, and equip.

Long-term investments

Goodwill

Other intangibles

Loans receivable long-term

Deferred tax assets, LT

Other long-term assets

Total assets

LIABILITIES

Accounts payable

Accrued expenses

Short-term borrowings

Current portion of long term debt

Current portion of capital leases

Current income taxes payable

Unearned revenue, current

Other current liabilities

Total current liabilities

Long term debt

Capital leases

Unearned revenue, non current

Pension and other post-retire. benefits

Def. tax liability, non current

Other non -current liabilities

Total liabilities

Common stock

Additional paid in capital

Retained earnings

Comprehensive inc. and other

Total common equity

Total equity

Total Liabilities and equity

2,863

18

2,881

362

439

9

810

1,319

127

5,137

9,655

(4,129)

5,526

976

251

347

87

358

921

13,603

2,284

1,035

37

372

50

101

30

229

4,138

2,757

1,025

55

113

115

713

8,916

358

9,916

(4,874)

(713)

4,687

4,687

13,603

2,688

3

2,691

349

352

12

713

1,209

492

5,105

9,878

(4,471)

5,407

1,105

254

365

81

429

1,187

13,933

2,37

959

38

369

51

141

88

242

4,025

2,250

992

47

96

173

910

8,493

358

9,916

(4,154)

(680)

5,440

5,440

13,933

2,600

2

2,602

337

379

67

783

1,331

478

5,194

10,993

(5,166)

5,827

1,120

373

389

32

410

1,380

14,725

2,323

1,039

39

19

59

243

95

275

4,092

2,348

1,096

35

129

177

938

8,815

358

9,916

(3,916)

(448)

5,910

5,910

14,725

2,438

2

2,440

369

405

4

778

1,466

509

5,193

11,583

(5,599)

5,984

1,170

404

432

32

394

1,371

14,980

2,436

1,095

41

429

67

136

38

372

4,614

1,986

1,158

29

94

199

1,023

9,103

330

9,094

(3,189)

(358)

5,877

5,877

14,980

Source: Capital IQ, accessed August 2012.

Dates of Filings: December 28, 2008, January 3, 2010, January 2, 2011, and January 1, 2012.

For the exclusive use of R. Lee, 2022.

This document is authorized for use only by Rebekah Lee in BU 650 Summer 2022 taught by Jordan Rippy, Johns Hopkins University from May 2022 to Nov 2022.

Ahold versus Tesco – Analyzing Performance 113-040

7

Exhibit 3 Tesco Income Statement

Income Statement

(millions of GBP) FY2008 FY2009 FY2010 FY2011

Total revenues

Cost of goods sold

Gross profit

General and administrative expenses

Operating income

Interest expense

Interest and investment income

Net interest expense

Income/(loss) from affiliates

Other non-operating income (expense)

Earnings before taxes excl. unusual items

Impairment of goodwill

Gain (loss) on sale of assets

Asset writedown

Earnings before taxes including unusual items

Income tax expense

Earnings from continuing operations

Earnings of discontinued operations

Net income to company

Minority interest in earnings

Net income

53,898

49,745

4,153

1,227

2,926

(400)

91

(309)

110

(78)

2,649

–

236

32

2,917

779

2,138

–

2,138

(5)

2,133

56,910

52,198

4,712

1,575

3,137

(531)

114

(417)

33

151

2,904

(131)

377

26

3,176

840

2,336

–

2,336

(9)

2,327

60,455

55,330

5,125

1,658

3,467

(465)

131

(334)

57

19

3,209

–

432

–

3,641

864

2,777

(106)

2,671

(16)

2,665

64,539

59,278

5,261

1,634

3,627

(417)

114

(303)

91

44

3,459

–

376

–

3,835

879

2,956

(142)

2,814

(8)

2,806

Source: Capital IQ, accessed August 2012.

Dates of Filings: February 28, 2009, February 27, 2010, February 26, 2011, and February 25, 2012.

For the exclusive use of R. Lee, 2022.

This document is authorized for use only by Rebekah Lee in BU 650 Summer 2022 taught by Jordan Rippy, Johns Hopkins University from May 2022 to Nov 2022.

113-040 Ahold versus Tesco – Analyzing Performance

8

Exhibit 4 Tesco Balance Sheet

Balance Sheet

(millions of GBP) FY2008 FY2009 FY2010 FY2011

ASSETS

Cash and equivalents

Short Term investments

Total cash and ST investments

Accounts receivable

Other receivables

Notes receivable

Total receivables

Inventory

Prepaid expenses

Other current assets

Total current assets

Gross property, plant and equip.

Accumulated depreciation

Net property, plant, and equip.

Long-term investments

Goodwill

Other intangibles

Accounts receivable long-term

Loans receivable long-term

Deferred tax assets, LT

Deferred charges, LT

Other long-term assets

Total assets

LIABILITIES

Accounts payable

Accrued expenses

Short-term borrowings

Current portion of long term debt

Current portion of capital leases

Current income taxes payable

Other current liabilities

Total current liabilities

Long term debt

Capital leases

Pension and other post-retire. benefits

Def. tax liability, non current

Other non -current liabilities

Total liabilities

Common stock

Additional paid in capital

Retained earnings

Treasury stock

Comprehensive inc. and other

Total common equity

Minority interest

Total equity

Total liabilities and equity

3,509

1,233

4,742

2,194

1,134

1,541

4,869

2,669

419

780

13,479

29,844

(6,692)

23,152

62

3,234

389

1,470

259

49

453

3,017

45,564

4,910

1,701

3,034

390

47

362

7,151

17,595

12,195

196

1,494

676

502

32,658

395

4,638

7,644

(229)

401

12,849

57

12,906

45,564

2,819

1,314

4,133

2,583

1,242

144

3,969

2,729

337

597

11,765

31,783

(7,580)

24,203

1,015

3,337

281

1,844

–

38

559

2,981

46,023

5,084

2,302

598

886

45

472

6,628

16,015

11,521

164

1,840

795

1,007

31,342

399

4,801

9,048

(180)

528

14,596

85

14,681

46,023

2,428

1,022

3,450

2,514

1,947

–

4,461

3,162

387

579

12,039

32,570

(8,172)

24,398

1,254

3,316

394

2,127

–

48

628

3,002

47,206

5,782

2,428

463

873

50

432

7,703

17,731

9,541

148

1,356

1,094

713

30,583

402

4,896

11,171

(141)

207

16,535

88

16,623

47,206

2,305

1,243

3,548

2,502

2,244

–

4,746

3,598

420

551

12,863

34,772

(9.062)

25,710

1,949

3,449

492

1,901

–

23

677

3,717

50,781

5,917

2,612

415

1,391

32

416

8,412

19,249

9,777

134

1,872

1,160

788

32,980

402

4,964

12,164

(18)

263

17,775

25

17,801

50,781

Source: Capital IQ, accessed August 2012.

Dates of Filings: February 28, 2009, February 27, 2010, February 26, 2011, and February 25, 2012.

For the exclusive use of R. Lee, 2022.

This document is authorized for use only by Rebekah Lee in BU 650 Summer 2022 taught by Jordan Rippy, Johns Hopkins University from May 2022 to Nov 2022.

Ahold versus Tesco – Analyzing Performance 113-040

9

Exhibit 5 Stock price performance

Source: Capital IQ, accessed September 2012.

Exhibit 6 DuPont Decomposition of Ahold and Tesco

Ahold Tesco

Decomposing Profitability

FY2009 FY2010 FY2011 FY2009 FY2010 FY2011

X

NI/Sales

Sales/Beg Total

Assets

3.20%

2.05

2.89%

2.12

3.36%

2.06

4.09%

1.25

4.39%

1.31

4.35%

1.37

X Beg Total

Assets/Beg Equity

2.90 2.56 2.49 3.53 3.13 2.84

= ROE

(ROA*Financial

Leverage)

19.07% 15.68% 17.21% 18.11% 18.

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