By James Davey and Paul Sandle
LONDON (Reuters) - Tesco , Britain's biggest retailer, beat forecasts for annual profit as its recovery gained pace, potentially strengthening the hand of boss Dave Lewis as he seeks investor backing for his plan to buy wholesaler Booker .
Tesco wanted the results, published on Wednesday, to reinforce its case that it can make a success of buying Booker in a 3.7 billion pound deal which it argues will help to drive growth in the medium term.
The supermarket group said its turnaround was ahead of schedule -- citing a 30 percent rise in its key profit measure, a first annual increase in underlying sales in its core UK business for seven years and a 27 percent reduction in net debt.
It also reiterated margin and cost savings targets.
However, shares in Tesco were down more than five percent to 185.1 pence by 1510 GMT, reversing its gains of the last week and indicating investors remain to be convinced of the merits of the deal and their broader concerns about the business.
Analysts also highlighted a tougher UK consumer outlook, intensifying competition and declining overseas margins.
DEFENDING THE DEAL
Two of Tesco's biggest shareholders last month urged it to drop the Booker bid, saying it was overpaying and the deal was a distraction from its turnaround plan.
Lewis, who joined in 2014 when the group was in crisis, shrugged off the share price fall.
"The critical thing for us is...Have we got a clear point of view about how we create value for Tesco? We have. And are we delivering against it as a management team? We believe we are," he said.
Lewis said he was positive about the overall reaction he has received from investors, noting that Tesco was paying a multiple of nine times operating profit once 200 million pounds of growth and cost synergies were factored in.
"A nine times multiple for a deal like this is a good deal. The fact that it returns its cost of capital in less than two years is very unusual in a transaction like this," he said.
Earlier this month analysts at Bernstein surveyed investors and estimated the deal would be approved by 70 percent of votes cast.
In January Richard Cousins, CEO of Compass the world's biggest catering firm, resigned as Tesco's senior independent director because he did not support the deal.
Lewis dismissed media reports that Tesco Chairman John Allan was a reluctant supporter.
"I do smile about it...It was a perfect board process," Lewis said.
Shares in Booker were also down 4 percent at 194p, reflecting the terms of Tesco's takeover -- 0.861 new Tesco shares and 42.6 pence in cash. That formula values Booker shares at around 202p.
TURNING THINGS AROUND
After Tesco's sales, profit and asset values were hammered by changing shopping habits, the rise of German discounters Aldi and Lidl and an accounting scandal, the company has been fighting back under Lewis.
He stabilised the business, then got it growing again with a focus on lower prices, new and streamlined product ranges, better customer service and improved supplier relationships.
Going for Booker is Lewis's boldest move yet, believing it will provide Tesco with a new avenue of growth by giving it access to the fast-growing "out of home" food market, given Booker's role as a distributor to the catering industry.
"My job is not just to be managing the short term for Tesco, it is about managing the medium and the long term," he said.
Tesco and Booker are engaging with Britain's Competition and Markets Authority (CMA), which has yet to formally confirm the start of an investigation which could last for months.
Tesco made an operating profit before exceptional items of 1.28 billion pounds in the year to Feb. 25, ahead of analysts' average forecast of 1.26 billion.
Group sales rose 4.3 percent to 49.9 billion pounds, while net debt was cut to 3.73 billion pounds.
UK like-for-like sales increased 0.7 percent in its fourth quarter, a fifth straight quarter of growth.
(Editing by Keith Weir and David Holmes)