LONDON (Reuters) - Tesco (TSCO.L), the world's No.3 retailer, has posted a drop in quarterly underlying sales in its main British market, resuming a trend seen for most of the past three years and raising doubts about its 1 billion-pound ($1.5 billion) turnaround plan.
Shares in the supermarket group fell up to 4.9 percent on Wednesday after it said it had suffered from weak demand for general merchandise as cash-strapped Britons cut back on discretionary purchases in a flagging economy, as well as the fall-out from Europe's horsemeat food contamination scandal.
Some analysts, such as Investec Securities' Dave McCarthy, have questioned whether Tesco can maintain its UK operating profit margin of 5.2 percent, even though the company said in April it believed that rate was sustainable.
Tesco, which makes about two thirds of its revenues in Britain, has struggled more than many rivals in part because it sells a higher proportion of non-food goods than other grocers and also because of years of underinvestment that saw it lose ground to rivals like J Sainsbury (SBRY.L) and Asda (WMT.N).
Philip Clarke, chief executive since 2011, has tried to rectify that by investing 1 billion pounds on more staff, new food ranges, revamped stores and lower prices.
However, sales at Tesco's UK stores open over a year, excluding fuel and VAT sales tax, fell 1 percent in the 13 weeks to May 25, at the bottom end of analysts forecasts for a fall of between 0.5 and 1 percent and reversing a rise of 0.5 percent in the previous quarter, which was the strongest quarterly result in three years.
"These results go to show that even with 1 billion pounds to throw at it, there are no guarantees," said John Ibbotson, director of retail consultants Retail Vision.
Despite the fall in underlying UK sales, Clarke told reporters his recovery plan was on track.
"What we're into is long term sustainable growth. It's going to ebb and flow over a quarter but the direction of travel is the right direction," said Clarke, a Tesco lifer who began his career with the grocer aged 14, stacking shelves in a store managed by his father.
Clarke said he was not expecting UK economic conditions to improve in the near term, despite an industry survey on Tuesday showing retail sales rebounded in May.
He forecast non-food like-for-like sales would remain down in the current financial year, but stressed it was a "top line" (sales) rather than a "bottom line" (profit) drag.
Tesco was reducing its exposure to weaker categories like consumer electronics, and increasing its focus on higher growth, higher margin categories like clothing, he said.
Analysts estimate Tesco's underlying non-food sales in the UK fell by a high single-digit percentage in the first quarter, while food sales were hit by the discovery across Europe of horsemeat in products labeled as beef. Tesco was one of several firms forced to withdraw some goods and apologize to customers.
Last month Britain's fourth-biggest grocer, Wm Morrison (MRW.L), posted a 1.8 percent fall in first-quarter underlying sales, while Asda, the second-biggest, reported a 1.3 percent rise, albeit for different trading periods. Third-ranked J Sainsbury (SBRY.L) is due to give a trading update on June 12.
Tesco's problems are not confined to Britain. Though total international sales rose 5.5 percent, the outcome was helped by favorable currency movements.
Like-for-like sales, excluding fuel, fell 3.8 percent in Asia, hit by restrictions on trading hours in South Korea, Tesco's largest overseas market, and weaker demand in China.
They also fell 5.5 percent in its continental European markets, hit by recession and stiff competition.
Tesco, which trails France's Carrefour (CARR.PA) and Wal-Mart, the world's biggest retailer by annual sales, makes about 12.5 percent of its group revenues in continental Europe. In April the firm confirmed it would withdraw from the United States.
Tesco's shares, up 20 percent over the past year, were down 16.6 pence at 347.8 pence at 8:52 a.m. ET, having earlier touched a four-month low of 346.7 pence.
But Panmure Gordon analyst Philip Dorgan said he believed Tesco's management is beginning to get a grip on the steering wheel and now has a clearer view of how its stores and online offer will develop.
"Remember that the darkest hour is just before dawn," he added.
Editing by Mark Potter and Greg Mahlich