Tesco says recovery plan working after profit collapse

By James Davey and Kate Holton LONDON (Reuters) - Britain's biggest retailer Tesco said it was trading ahead of expectations and outperforming rivals after a move to sacrifice profits in favour of investment in lower prices and better service won back customers. Reporting first half results a week after rival Sainsbury's showed it too was getting to grips with the turmoil in the supermarket sector, Tesco showed a sustained improvement in underlying sales in its key home market which enabled it to reiterate its full-year profit guidance. The cost, however, of rebuilding a business that was on its knees this time last year was high. Tesco's first half profit slumped 55 percent and Chief Executive Dave Lewis said on Wednesday he stood ready to further increase investment given market challenges in the second half. Shares in the group traded 1.9 percent higher at 0926 GMT. After two decades of growth, Tesco lost its way, distracted by an expensive overseas expansion strategy when it needed to respond to the rise of discount grocers Aldi and Lidl at home. It reported an annual loss of 6.4 billion pounds in April, one of the biggest in British corporate history and has struggled to recover from an admission that it manipulated its accounts last year. "We have delivered an unprecedented level of change in our business over the last 12 months and it is working," said Lewis, a former Unilever executive who was brought in by Tesco in September 2014 to turn the business around. VIRTUOUS CIRCLE Against Tesco's six major benchmarks, profit, sales, cash, customer loyalty, staff and supplier satisfaction, it was either on or ahead of target, Lewis told reporters. "Critically the virtuous circle is beginning to work again as volumes grow," he said. Transactions in UK stores were up 1.5 percent, with volumes, the amount of goods people are buying, up 1.4 percent. Lower prices meant however that UK like-for-like sales still fell, albeit at a slower rate. They were down 1 percent in the second quarter, an improvement from the 1.5 percent decline recorded in the first. That was at the top end of analyst expectations of a fall of between 1 to 1.5 percent and better than Sainsbury's, Asda Asda and Morrisons . Lewis said a typical basket of Tesco shopping was 3 percent cheaper year-on-year. He expects more deflation in the second half. "We don't see the market condition changing," he said. International sales, which account for more than a fifth of the group total, showed their first like-for-like increase in nearly three years in the first half, helped by a recovery in Poland and Slovakia. One major Tesco institutional shareholder welcomed the results. "The stand out for me was the comment on volume and transaction growth," he said, speaking on condition of anonymity. "That suggests that something is improving on an underlying basis." BALANCE SHEET CONCERN One major concern lingering around Tesco is the strength of its balance sheet. Lewis wants to slash debt and rid the firm of its junk credit rating. However, Tesco said on Wednesday no further major disposals were planned following the recent sale of its South Korean unit for $6.1 billion, which cut total indebtedness to 16.5 billion pounds. Tesco will now retain its Dunnhumby data unit after a planned sale flopped. Lewis said further debt reduction would come from better cash generation from its retained businesses, while seeking cash from shareholders was not being considered. Finance chief Alan Stewart said Tesco was not under debt pressure. "We’ve got liquidity, we've got 5 billion pounds of facilities," he said. However, some analysts are still to be convinced. "We continue to believe that Tesco will need to raise capital and potentially a considerable amount in order to progress without looking over its ‘balance sheet shoulder'," said Shore Capital analyst Clive Black. (Additional reporting by Paul Sandle and Emma Thomasson; Editing by Keith Weir)