Chief Executive’s statement

These results show that it has been another successful year for Tesco. The numbers are solid, the growth is broadly based – coming from all four parts of our strategy – and we have delivered tangible benefits for shareholders.

I’m pleased about that because these things are never easy. The most encouraging thing about this performance is that we’ve coped well with the head-wind from recovering competitors, rising costs and tough conditions in some markets. We’ve come through in good shape and we’ve done it by staying focused on doing the right things for our customers and at the same time investing for future growth.

I’m a committed Tesco shareholder. For me, the Tesco investment case is about three things: strong, sustainable growth through serving customers; disciplined investment; and good returns for the owners of the business – now and in the long term. We have a good track record of delivery on these things – and there’s more to come.

Growth

We have laid solid foundations for future growth. Our new businesses are coming of age – they are profitable, they have scale and they are competitive. I believe they can now provide us with years of strong growth – because in ten years, we’ve moved from reliance on a market of 60 million people to being able to access markets with over two billion people.

I’m also an investor in Tesco because I see the prospect of rising returns – by that I mean both return on capital employed – and the return of income and capital to shareholders.

Last year, we set a new return on capital employed (ROCE) target – to add another 200 basis points. ROCE grew in 2006/07, which is a great result given the start-up costs in Tesco Direct and the US – plus almost £400 million of investment in acquisitions. The underlying progress on ROCE has been even stronger – before the effect of those factors it was up 50 basis points – and we’re on track to hit our target.

It has also been a good year for shareholder returns, which are up 36%. Of course, our shares are higher in buoyant markets but we’re also doing more to contribute. Dividends are up to approaching £800 million, driven by last year’s change in policy, combined with the effect of our rising flow of property profits now ranking for dividend. We have also bought back and cancelled almost £470 million worth of our own shares so far.

We know one of the reasons for the strength of our shares is property. As market yields have fallen, property has become a bigger element of the embedded value in the business – and we’ve played our part in raising awareness of this – mainly by selling some. The appetite for property is so strong that our two recent Joint Venture (JV) deals achieved a premium to bookvalue of almost 100%, on initial yields under 4.5%. This success, and the good experience we have had operating our stores in the JV’s, has encouraged us to do more. Our enlarged property funding programme is behind the doubling of the share buy-back.

That said, property is an integral part of a retail business – and it is important that we strike the right balance between returns today and value tomorrow. So we will retain the necessary long-term strategic strength we see in ownership by keeping at least 70% of our assets in freehold.

To sum up, our focus remains on profitable growth – building on the solid foundations we have laid over the last ten years. At the same time, we’re always looking to improve the way the owners of the business benefit from that growth.

As a company we are putting increasing focus on our work with communities and the environment. We’ve built our success on listening to customers and these things are growing in importance for them. That’s why I believe the battle to win their loyalty will increasingly be fought not just on value for money, range and convenience, but on being good neighbours, behaving responsibly and seizing challenges such as climate change.

I think these will be positives for us. Customers want to do the right thing – they’re just not always sure how – whether it’s a healthier diet or consuming in a greener way. It’s a classic consumer need – and one which I believe Tesco is well placed to meet. That’s why we’ve made it part of the Tesco Steering Wheel.

As investors, you need to know that we see these things as opportunities – so it is also important that Tesco leads.

Above: Dacheng E. store, Beijing, China
Right: Selamattin Sicdaz, Bornova Forum, Turkey

International

Our biggest opportunity for growth and for improved returns is International – and it underlines the breadth of our business.

Overall, we have produced a very good performance – particularly against the background of political uncertainty and economic problems in three of our largest markets – Hungary, Thailand and South Korea. This demonstrates that International now has the size and momentum to get through these things and still deliver.

Two years ago I began to lay out how we had evolved a strategy for international expansion from a decade of experience. Today, given how much retrenchment is going on among retailers with international ambitions, I thinkwe can claim that this has developed into one of the most successful – if not the most successful – approach to international retailing.

It is about being flexible; being local; maintaining focus on a few countries; using multi-formats to reach the whole market; developing capability; and finally, – once you’ve put in the networks, it’s about building the brand.

I know this approach is now more familiar to you – but I’m going to highlight the significant developments of the past 12 months using some of these six elements – starting with focus. Through a combination of organic expansion and several good inmarket acquisitions, we’ve made excellent progress in building stronger positions in all of our existing countries.

Across our 11 markets, we opened 8.2 million sq ft of space – four times the amount added in the UK and over 50% more than the year before. We plan to add over 7.5 million sq ft more this year – all of it organic, even without the stores in the United States.

We have got much stronger in Central Europe, through rapid growth in new space and acquisition. For example, sales have increased by almost twothirds in the Czech Republic – helped by the Carrefour and Edeka stores – taking us into the leading group of retailers in the market. In Poland, sales were up 22% with only a few weeks’ contribution from the Leader Price stores. These are rapidly being converted to our 1k format – with sales uplifts so far averaging 25%. Profits rose almost 50% in Poland.

Pushing on faster in these markets is paying dividends. Not only are returns improving – but as the most profitable and rapidly growing retailer we are able to participate in consolidation from a position of strength – and buy only the right assets at the right price.

In Asia as well, having done the groundwork in a couple of our newer markets, we’ve used acquisition to get on faster. The eight Makro stores will double our space in Malaysia when converted. In China, we’ve taken a controlling interest in Hymall, which now has 47 hypermarkets, including stores in Guangzhou and Shenzhen, plus the first Tesco branded store in Beijing – all of which opened well. 90% ownership will free the business from capital constraints and permit a faster rate of growth, through freehold development.

Our progress with multi-format has been very good, giving us more options for expansion and extending our reach into markets. Our experience means that we are able to calibrate formats more quickly for local customers, get to profitability and move faster into roll-out.

Our 1k stores are popular with customers and we now have over 200 of them trading across Central Europe. The universal appeal of Express means that it trades from almost a million sq ft of our international space. It is well established in Thailand, where we have a good forward programme and we will double the number of Expresses in South Korea this year – to 79 stores. Our trials in Japan are going well and we already have 15 Express stores in Turkey. Our first Central European Express – in Prague – will be opening soon.

The principles behind these formats are common, but the offer is local – designed by local teams for local customers. We’ve used this approach in putting together our 10,000 sq ft Fresh & Easy Neighborhood Market format for the US. Preparations for the launch later this year are going well. We have a strong team of over 150 at El Segundo and the construction of our 820,000 sq ft distribution centre at Riverside is on schedule.

We plan to open a significant number of stores at launch – across LA, Phoenix, Las Vegas and San Diego – and we’ve made good progress in obtaining quality real estate for them.

International returns are making steady progress towards the mid-teens numbers we require – improving to 11.5% with a high proportion of capital – over 70% – less than five years old.

Looking at the significant changes over the last 12 months for returns by country – not surprisingly, Hungary has slipped a bit – because we’ve chosen to push on with expansion in a very weak economy. It will come back. South Korea and Thailand have improved but the really pleasing thing is that Poland – which is our third largest investment and the Czech Republic – have both improved compared with last year – to like-for-like cash return on investment (CROI) approaching 10%.

Not only are returns still improving, cash flows are strong too. EBITDA in International was over £800 million in 2006/07. After working capital gains, this means that International funded more than 90% of its own CAPEX.

Right: Pitsea Extra, UK
Far right: Carol Sargeant, Pitsea Extra, UK

United Kingdom

At the start of the year, we set out to make progress in an environment with recovering competitors and cautious consumers feeling the full effect of last year’s energy cost and interest rate rises. Because we’ve been on good form operationally, we have coped well with those things – delivering good sales – and also strong profit growth, whilst carrying more than £40 million of start-up costs on Tesco Direct and the United States.

Two factors have been driving this. First, the real improvements we’ve made to the shopping trip for customers. We can always get better – but I want to highlight a few things we’ve done this year on price, service, range and availability.

Our price check survey, which compares 10,000 prices against our leading competitors weekly, shows that our position has improved again during the year.

On service, the implementation of new checkout technology across our stores means that we can now monitor and manage the checkout service customers receive much more precisely – by customer, by store and by the hour. As a result, over 350,000 more customers a week benefit from our ‘one-in-front’ checkout queue promise.

We’ve also made significant changes to our food ranges in response to customer demand, introducing more Organics, free from, Healthy Living, Wholefoods, Fairtrade and Kids products, as well as over 1,000 more premium lines – including over 250 Finest.

On-shelf availability, which we measure using our in-store picking of tesco.com orders, has also improved again and more customers are able to buy everything they want. The most marked increase has been achieved in fresh foods, where we have seen a fifth consecutive year of improvement.

For decades, food has been a falling proportion of total consumer spending. As a business we have contributed to this – by cutting prices to help people spend less. That won’t change – but the long-term trend of declining spend on food has changed – it has stopped.

This is significant and I believe we’re seeing a fundamental shift in the priority consumers place on food. The link between diet and health, interest in cooking, provenance – including local and Fairtrade – it is more than simply trading up. It is also not just about affluent customers – it’s everyone and that means it could be a big long term positive for our industry.

We can see these changes all around the store – with healthy foods growing nearly twice as fast as the rest of the business. A good example is Organics where sales are growing four times faster. In just 12 months the proportion of our customers buying organics is up by over a third – to more than 40% – and the growth is fastest among less affluent customers.

Right and far right: Chelmsford Homeplus, UK

Non-food

Non-food has again made very good progress, with sales growing significantly faster than in our core operations. It is now a £7.6 billion business in the UK alone – and well over £10 billion for the Group as a whole.

UK non-food sales growth was 11.6% in the year and volume growth was even higher, driven by our ability to pass on lower prices to customers. Non-food price deflation was over 3%, funded by our growing scale and supply chain efficiency and the benefits of more direct sourcing in Asia.

Most of our established categories, which benefit less from new space, grew well. For example, health and beauty sales increased by 9% and so did news and magazines. The exception was entertainment, where we saw market share gains but weak sales driven by deflation and the increase in downloading. We are putting plans together to build a strong position in the digital market.

Our newer categories again saw excellent growth. Clothing sales grew well – up by 16% – in a tough market, which was partly affected by unseasonal weather. We made strong market share gains by volume and value. Some product groups, to which we have been able to allocate more space in our larger Extra stores, did particularly well. Consumer electronics were up 35%, toys and sport up 30%, DIY and stationery were both up 23%.

Our overall non-food market share is 8%. With our relatively low market shares in many categories, the growing popularity of our offer with customers, the scope to expand our stores and also sell more though direct channels, there is a lot of growth to come.

Last September, we started Tesco Direct in a low-key way to let customers know about it, test the systems and make sure the logistics were ok. This went well, so a month ago we were able to go live on the full launch – with 11,000 items on our website, 7,000 of which are in our catalogue.

As well as great prices and wider ranges, Tesco Direct offers customers an unrivalled choice of ordering and delivery options. Two-hour home delivery slots have proved very popular. So has the option to pick-up from store – which is why we’re going to make it available in as many stores as possible – starting with 200 from this year. The feedback on the launch has been good – the catalogue has been extremely well received and volumes are encouraging.

Right and far right: Royston Extra, UK

Retailing Services

Our retailing services, another indicator of the growing breadth of the business, have made further good progress – helped by our position as a leading internet retailer. Dotcom was on excellent form, with sales up 29% and profits – before the start-up costs of Tesco Direct – increasing nearly 50%.

Tesco Personal Finance (TPF) hasn’t been immune from the effects of a difficult retail financial services market. However, I’m optimistic for the future. TPF is the best business of its kind in the market, it is high returning and under the new team there, I think it will get back to a faster rate of growth. 50% of TPF’s product sales are now on-line, providing a strong platform from which to build.

Telecoms passed an important milestone in the year – when it moved into profit during the second half. Customer numbers also rose strongly, attracted by its combination of simple, great value tariffs, good service and innovative new products.

In summary:

• Tesco is about growth and we are confident of sustaining strong growth into the future
• We do this by following the customer – and as they change, we change
• At the same time, we can deliver improving returns and tangible benefits for shareholders
• We are playing our part in tackling some of the social and environmental challenges we all face
• We’ve delivered strong results across the Group by making shopping better for customers
• Tesco is about investing for the future and delivering today – and I’m confident that the business is well-placed to meet the challenges which lie ahead.

Terry Leahy Chief Executive

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