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Tesco ready to take on U.S. grocers, analyst says

CHICAGO (Reuters) - Tesco Plc TSCO.L faces an "ultra-competitive" market as it prepares to enter the United States and, while its initial impact on rivals is likely to be minimal, retailers and investors need to pay attention to its plans, Credit Suisse analyst Edward Kelly said on Wednesday.

A line of Tesco trolleys stand outside a store in London October 3, 2006. Tesco Plc faces an "ultra-competitive" market as it prepares to enter the United States, and while its initial impact on rivals is likely to be minimal, retailers and investors need to pay attention to its plans, Credit Suisse analyst Edward Kelly said on Wednesday. REUTERS/Luke MacGregor

Last week, Tesco, Britain’s biggest retailer, said it would initially target the greater Phoenix area, Las Vegas, Los Angeles and San Diego for its new U.S. stores, to be called “Fresh & Easy Neighborhood Market.”

The stores, which are smaller than supermarkets or mass market stores, are to start opening later this year.

In a note entitled “It May Be Fresh, But It Won’t Be Easy,” Kelly said Tesco’s plans to open U.S. stores “could represent one of the major structural changes to face the retail industry in some time.”

While it should take time for Tesco to test and perfect its model before moving beyond its initial areas, “retail competitors and investors need to consider the ramifications now,” Kelly wrote.

He estimated Tesco’s Fresh & Easy stores could generate $1 billion in sales within three years and grab 2 percent to 6 percent of local market share in five years.

But Tesco will have to differentiate itself from existing chains to grab consumers’ attention, Kelly said.

He believes Tesco's U.S. stores will be a hybrid, bridging the gap between traditional grocers, such as Kroger Co. KR.N and specialty supermarkets such as Whole Foods Market Inc. WFMI.O and privately held Trader Joe's, while adding the appeal of mass market stores, such as Costco Wholesale Corp. COST.O, Target Corp. TGT.N and Wal-Mart Stores Inc.

Kelly said Tesco’s growth would likely accelerate after its second year in the United States and it could look at acquisitions to move into attractive locations.

He added he believes some retailers are working on possible responses to Tesco’s arrival, such as new store formats or upgrades to their existing formats.

“It’s too early to short supermarket stocks,” Kelly wrote.

He expects supermarket earnings to remain solid in the near term, but said “investors with a longer term time horizon should not overlook this potentially large negative catalyst.”

Traditional U.S. grocers have already been improving their decor and offerings, with chains such as Safeway Inc. SWY.N expanding deli and bakery sections and adding more prepared gourmet-style items, such as refrigerated soups.

After Safeway's so-called "Lifestyle" plans led to increased sales, rival Supervalu Inc. SVU.N said in November it would spend about $1 billion to remodel stores and open new outlets, under a program dubbed "Premium Fresh & Healthy."

Smaller chains, such as Great Atlantic & Pacific Tea Co. Inc.'s GAP.N Food Emporium, are also making changes to keep consumers interested. In late 2006, Food Emporium opened a remodeled, upscale supermarket in New York City to compete with Whole Foods and Trader Joe's, which have expanded into Manhattan.

Tesco confirmed last week that its stores would be just 10,000 square feet, making them much smaller than a traditional 45,000 square-foot grocery store.

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