Shares in Tesco (TSCO) ticked up 3.85p to 372.95p in early trade today, as the global grocery behemoth confirmed talks are underway regarding a potential joint venture in the world's second-biggest economy.

 

In a short and sweet statement, the £29.7 billion cap flagged exclusive discussions with Hong Kong-listed China Resources Enterprise (0291:HK), 'CRE', to combine their Chinese operations and form a retail giant with sales of £10 billion.

 

Discussions appear to be at an advanced stage, as Tesco confirmed it would take a 20% stake in the joint venture with state-run CRE controlling 80% of the new chain.

 

Under the terms of the mooted tie-up, Tesco would combine its 131 China stores and shopping mall business with CRE's CR Vanguard business, which runs almost 3,000 stores across the Peoples' Republic and Hong Kong.

 

Web chart - Tesco v grocers - Aug 2013

 

From Tesco's point of view, the planned partnership is consistent with chief executive Philip Clarke's strategy to focus on 'profitable routes to growth in fast-growing but less mature markets'.

 

An agreement would allow the grocery giant to reduce the amount of capital it must commit to its Chinese business and yet still retain a presence in this attractive market.

 

Tesco, which faces challenging conditions in many international arenas, is transforming itself into a more focused, highly cash generative and return on capital employed-driven entity under the stewardship of Clarke.

 

Following exits from Japan and the USA, the FTSE 100 retailer has called an end to the so-called 'space race', stating it would pare back spend on large multi-use developments and push ahead with its self-improvement plan in its core UK market.

 

In a bullish note published this morning, Jefferies International, with a 'buy' rating and 440p price target for Tesco, writes: 'Today's announcement confirms that our assumption for rational steps to be taken by the group is a sensible one. The Chinese dilution to the group's cashflow profile was probably the one that needed most urgent action (we assume that Tesco has invested a cumulative capex of at least £2bn between Chinese retail and malls), but we also believe a very similarly structured deal is available to the group in Turkey. Tesco's current valuation clearly ignores these opportunities.'


Issue Date: 09 Aug 2013