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Edited Transcript of TSCO.L earnings conference call or presentation 4-Oct-17 1:15pm GMT

Thomson Reuters StreetEvents

Half Year 2018 Tesco PLC Earnings Debt Investor Update Call

Hertfordshire Oct 5, 2017 (Thomson StreetEvents) -- Edited Transcript of Tesco PLC earnings conference call or presentation Wednesday, October 4, 2017 at 1:15:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alan Stewart

Tesco PLC - CFO

* Lynda Heywood

Tesco PLC - Group Treasurer

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Conference Call Participants

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* Rebecca Clements

Fidelity International - Analyst

* Toby Hunston

Insight Investment - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to today's call. (Operator Instructions). Please note that this conference call is being recorded.

And I would now like to hand over to Alan Stewart, CFO; and Lynda Heywood, Group Treasurer. Please begin your meeting.

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Alan Stewart, Tesco PLC - CFO [2]

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Thank you very much and good afternoon, everybody. Apologies for joining this call slightly late; having to make a journey from central London up to Welwyn where we are, and shortly going to be briefing all of our colleagues. So, in terms of our -- I will give you a brief -- Lynda and I will give you a brief recap on the key elements of the presentation. Implicitly in what I've just said I'm joined by Lynda, who as you know, is Group Treasurer. I'm very grateful for your time today.

So in terms of the half year that we've just reported on, we've delivered another strong financial performance, continued momentum in sales, which have grown at 3.3% at actual rates, and 0.7% at constant rates, to a total for the half year of GBP25.2 billion. This means that we've now delivered seven consecutive quarters of growth in both the UK and in the Group.

Our operating profit, at GBP759 million, was up 27% year on year, driven largely by the UK. And we've also seen strong margin progression in both Central Europe and Asia, too, with profits commensurately improving.

Overall Group margins are up 50 basis points to 2.68%. And we generated GBP1.1 billion of cash, which is up 19.3% year on year; means we're firmly on track to achieve our GBP9 billion cost -- cash targets in the three years that we laid out.

If we move to the headline results on the UK and ROI segment, we've seen positive like-for-like growth of 2.1% for the half. The market conditions have been challenging; and we've seen, as I'm sure you're all aware, the return of inflation. But we've been able to protect our customers from more of this pressure than others in the market by working closely with our supplier partners. Our inflation we estimate is running at about 1 percentage point behind the market.

As you can see from the waterfall on the right, the UK and ROI operating margin has increased by 32 basis points to 2.1%. We have continued to invest in price for customers and this has contributed to the continued volume growth. And we've tried to split this out in the waterfall. These often mask offsetting movements beneath the data. And in this case, we've had strong positive fresh food volumes partially offset by declines in other categories; for instance, general merchandise, where we continue to be far more selective in the volume we drive. And then finally I'd highlight the significant progress we've made in reducing cost towards our GBP1.5 billion Group cost reduction target.

If we now move to the next slide, which is on Central Europe. As you will have seen from the press release, we have reported Central Europe and Asia as separate segments, which reflect the way we run the business and the changes in our management structure earlier in the year.

In Central Europe, we've seen an improvement in performance in the second quarter, predominantly once again driven by food. And we continued to see strong like-for-like growth in the Czech Republic and in Slovakia. In Poland, which remains extremely competitive, we've also seen an improvement reflecting our ongoing investment in the offer. The operating margin in Central Europe has increased by over 130 basis points to 1.9%, driven largely by the significant cost savings we made in that region of GBP42 million.

Partly offsetting this, we have seen inflation across the region which spread through into our cost base. And this led to some sales inflation, which we've been able to mitigate some of by working with our suppliers to the benefit of our customers.

We then turn to the Asia segment. As we mentioned in the first-quarter announcement, our like-for-like performance has been impacted by our decision to stop unprofitable bulk selling activity in Thailand. We solve that through the whole of the second quarter as well. Asia's like-for-like for the half, after stripping this impact out, was down around 2 percentage points, largely reflecting a reduction in short-term promotional couponing activity, predominantly in the second quarter, and again in our Thai business. This promotional activity is running at around half the previous level.

You can see the positive impact that these strategic decisions had when you look at the waterfall on the right of this chart. Whilst the market is seeing selling price inflation, we've continue to invest in keeping prices low for our customers, and our mix has significantly improved. With the continuing focus on reducing the cost base, the margins are up by nearly 150 basis points in this segment.

If we then look to the sources and uses of cash. We're really pleased with the continuing improvement in our operating cash flow. As you will have seen from the release, we've changed our measure of retail cash flow to better reflect the cash that we end up at, available for the business and for our shareholders. As such, we now showed [after] property transactions, exceptional items, and business disposals. The waterfall shows you the way that we think about it within the business, and I'll just run through that.

If you start from the left with the GBP1.149 billion of cash from retail operations, this is up 28.5% year on year, excluding working capital. I should point out that this includes the cost of our pension deficit funding. If we then look at the working capital, we've had a positive inflow of GBP237 million as a result of our continued focus in this area, particularly on stock and trying to get our stock turn faster.

This includes a 10% increase in something we've spoken about earlier and before, which is the number of times we touched product between the back door of the store and of the shelf. And we've seen an 10% increase in the one-touch replenishment in UK packaged food, now running it to say that 70% of our stock here is only touched once.

We've also seen a more efficient promotional strategy in Central Europe. And for the second half, we expect a further albeit much smaller improvement in working capital.

Going forward, we are looking to generate around GBP200 million per year improvement in working capital. The exceptional cash items resulted in an outflow of GBP247 million. Within this, there's GBP135 million of payments in relation to the deferred prosecution agreement with the SFO, and the initial shareholder compensation scheme payments. And there are also GBP84 million of restructuring costs.

The majority of these relate to provisions made last year. That's GBP55 million. And GBP29 million, the balance, relates to new payments in the first half. This then leads to an overall operating retail cash flow of GBP1.139 billion, up 19% year on year. Again, you can see some of the details of this track back directly into our financial statements accompanying the release.

I'll come to CapEx in more detail, but it's important to note that the CapEx shown here is the cash CapEx, and partly reflects significant year-end accruals which have now been paid.

Net interest and tax payments of GBP173 million were GBP88 million -- so sorry, were GBP38 million lower than last year, largely as a result of the significant debt reduction program which we've achieved over 12 months.

Our net property transactions include the consideration related to the transaction with British Land which we did announce back with our full-year results, in which we regained sole ownership of seven large stores in the UK. This was mainly funded by GBP138 million of proceeds from property sales, including the completion of the sale of our Hackney store as part of our air rights program and of the sale of a further 50 sites.

We raised GBP277 million through disposals and dividends received, mainly through the sale of our remaining minority stake in the Lazada online business in Asia. As a result, our overall free cash flow for the half is GBP586 million. This reflects the strong underlying profitability and the working capital improvement offset by the SFO payment and the timing of cash CapEx from property transactions.

A little bit more detail on CapEx. Now, for the first half, it was GBP427 million, largely made up of our continued maintenance and refresh program in the UK. The GBP45 million which you see in the regional analysis for Central Europe reflects the space repurposing we've been carrying out and from which we're seeing good returns. In Asia, we spent GBP74 million, and this relates to 33 new stores we've opened, primarily in the convenience [format], and the repurposing of the 11 stores.

We now expect our CapEx for the full year to be at around GBP1.1 billion as we have continued to benefit from efficiencies in both the purchase and the use of capital. Going forward, we expect annual CapEx to remain between the GBP1.1 billion and GBP1.4 billion range.

We've included on the next page a couple of slides on the pension to help explain the movements that you've seen here. First of all, and I think most important from the cash perspective, is that I'm pleased to say that we've concluded the triennial (inaudible) evaluation and have agreed with the trustees and the regulator that our annual contributions will increase from GBP270 million by GBP15 million to GBP285 million from April 2018. This long-term framement -- and though long-term framework for the agreement with the trustees, which we set up three years ago, remains unchanged.

The valuation confirms the actuarial deficit of GBP3 billion as of March 2017, an increase of around GBP250 million from the previous valuation actuarially in March 2014. This reflects the updated view on the expected future performance and returns, the actual scheme experience, plus of course the market performance of the assets since the last valuation.

Given the understandable interest that always surrounds the pension position, it's worth pointing out that our scheme is very young compared to the majority of schemes, with only 18% of all of our members currently drawing a pension. And more importantly, that this -- that our liabilities are very long-term, with over half of the benefit due to be paid in the period beyond 30 years. We've got a long-term plan to manage the funding of these liabilities and a balanced mix of assets to reflect this. Our intention remains to get to a level of self-funding within the scheme over the longer term.

If we then turn to the next slide, which shows the movement in our IAS 19 pension deficit. This has reduced significantly to GBP2.4 billion as of the end of August on a net-of-tax basis. You can see from this waterfall that in addition to the gains in the scheme assets, there have been three key factors driving the reduction.

Firstly -- and this is around 55% of the total reduction -- the change that we've made in the discount rate, which we believe more appropriately reflects the corporate bond yields over the life of the scheme's liabilities. And secondly -- this is 45% of the reduction -- we have applied the latest industry life expectancy tables, consistent with what the actuaries used in their review. And we've had positive scheme experience, and again consistent with what the actuaries have seen, since the last funding valuation in March 2014.

And just finally on balance sheet progress, before I hand over to Lynda. Along with the pension deficit, we've also made further progress towards strengthening our balance sheet. Our net debt has reduced to GBP3.3 billion, reflecting the improved cash generation I spoke about earlier. We repaid around GBP1.1 billion of gross debt in the year, (technical difficulty) GBP500 million bond tender exercise we completed in the first half of the year. And we'll see the benefits of this reduced interest cost in the future.

We've also seen a reduction in our lease commitments following the buyback of the seven stores I previously mentioned. So our total indebtedness now stands at GBP13 billion, a GBP8 billion reduction from 2014. In the three years since August 2014, our net debt has reduced by more than GBP4 billion or by about 56% reduction. And our total indebtedness has reduced by GBP5 billion.

I'll now hand over to Lynda.

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Lynda Heywood, Tesco PLC - Group Treasurer [3]

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Thanks, Alan. Just now talking about our debt metrics. As you can see, the improvement in net debt and the reduction in lease debt as well as the reduction in the pension deficit has driven a significant improvement in our total indebtedness ratio, which is the measure that's closer to the adjusted net leverage ratios used by the rating agencies.

However, we've also reduced the net debt/EBITDA leverage ratio from 1.6 times to 1.3 times as a result of the reduction in net debt, as well as improved profitability. And we have continued to improve our fixed charge cover, which we define as EBITDA over interest and rent, which is now up at 2.4 times.

We maintain a very strong liquidity position, with GBP3.8 billion of cash and short-term investments. This is after netting GBP1.3 billion to cover the reported overdraft. I'll come back to this later. And also excluding the GBP0.8 billion of cash held aside for the Booker transaction.

In addition to cash, we also have access to GBP4.4 billion of committed facilities which remain fully undrawn, and have remaining tenures of 2 to 4 years.

In the first half we have deployed cash to accelerate debt repayments, including the GBP500 million bond tender and the early repayment of a secured bank loan relating to a property JV acquired in 2015-16.

Going forward, we have GBP3.3 billion of bonds maturing in the next 2 1/2 years, which can be covered from our current cash. And beyond these upcoming maturities, we benefit from a very well-balanced maturity profile, extending out to 40 years.

On the next slide, which is slide 13, we provide details of our tender offers, which were aimed at reducing gross debt and interest cost. We (technical difficulty) target long-dated bonds across dollar, euro, and sterling, where we saw the best value and where we also had the opportunity to unwind derivative positions.

Consequently, despite a purchase consideration of GBP550 million for the bond, our net cash outlay was only GBP440 million. And we were able to achieve annual interest savings of some GBP20 million over and above the interest forgone on invested cash. We were really pleased with the outcome of our transaction and delighted with investor response to the offers. Going forward, we will look to -- we will continue to look for opportunities to optimize our debt portfolio.

On the next slide we provide some information on the composition of our gross debt. The bar chart shows the split of total gross debt between (technical difficulty) and long-term debt. The reported GBP1.3 billion of bank loans and overdrafts represent only the notional (technical difficulty) on our cash pool, which is why we exclude it from long-term debt and instead net it off our cash.

Our long-term debt now consists of senior unsecured bonds in euro, dollar, and sterling, and around GBP0.6 billion of secured debt, known in the market as (inaudible) finance bonds. These were part of the GBP1.5 billion of debt brought on to the balance sheet as a result of property transactions completed in our financial year 2015-16. The remainder of that balance has now been repaid. Our debt is 77% in sterling or swap to sterling, with the remainder kept in euro as a net investment hedge against our euro-denominated businesses.

On slide 15 we show the performance of our CDS against the iTraxx Crossover, of which we are a constituent part, and also against the main iTraxx Investment Grade Index. After our last call, we did have a question about the validity of using the CDS to track our credit spread performance. So this time we also added on to the graph our Euro 2024 bond, which is our most recent benchmark bond issued in June 2014.

As you can see, the CDS does appear to be a pretty good proxy for our credit spreads, which are continuing to tighten. On credit ratings we -- there is no change in our credit ratings. We are stable BB+, Ba1, with all three agencies. And this was reconfirmed following the announcement of our proposed merger with Booker earlier in the year. We have good dialogue with the rating agencies and clear expectations of what is needed for a ratings upgrade in terms of leverage and margin targets, as we do remain committed to returning back to investment grade.

I'll now pass back to Alan to summarize.

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Alan Stewart, Tesco PLC - CFO [4]

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Thanks, Lynda. So in terms of the summary, we're delivering against the strict six strategic drivers we set out and that we spoke about earlier in our presentation in the city this morning. We've had another half of strong performance across the whole Group with the 3.3% in sales growth, the 27% increase in operating profit, margin up 50 basis points across the Group, and the 19% increase in retail cash generation.

We've announced the reinstatement of our dividend, reflecting the Board's confidence in our recovery and the future performance of the business. And our balance sheet is in a significantly stronger place. We repaid, as Lynda said, the GBP1 billion of debt in the half, including the GBP500 million bond tender. We've also agreed with the pension trustees the annual pension contributions of GBP285 million per annum, starting in April 2018, and we continue to see improvements in our debt metrics.

So that brings the end to formal presentation. In the deck we've also given you a page on the guidance, which we brought together and which we spoke about the -- to the city. Two points I'd bring up on that. We look at the net finance cost at about 4% of our long-term debt as the best proxy we can see for the cost of our interest going forward. And the effective tax rate we've guided to around 25% for the current year. And we expect, in the medium-term, that this will decrease to around 20% as the mix of our profitability changes and we recover greater profitability in the UK.

That's it. Very happy to take any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Rebecca Clements, Fidelity International.

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Rebecca Clements, Fidelity International - Analyst [2]

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Just a couple of questions on -- first, around the tender that you did earlier this year for the long-dated bonds, we were a little bit surprised that you targeted those particular bonds. And I was just curious, was the decision from an economic perspective, primarily driven by the derivatives unwind?

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Lynda Heywood, Tesco PLC - Group Treasurer [3]

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Not primarily. We look at these things in the round, and then take a view on the relative economics of unwinding any of the bonds. So, it wasn't purely based on the derivatives. It was done over -- looking at the package to ascertain the economic benefit to us.

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Alan Stewart, Tesco PLC - CFO [4]

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What I could add to that is that we had a very good present value when we looked at it in terms of the cash that we're spending compared with what we were saving. And unusually, we also got a [P&L] credit in respect of that, which is relatively unusual. As Lynda said, it was much more to do with an in-the-round view of the overall portfolio, where it was, than specifically linked to the swaps.

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Rebecca Clements, Fidelity International - Analyst [5]

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Okay. Because I guess the way I was looking at it is, if you are going to be paying upcoming maturities as they come due, we were just a little bit surprised that you went for the longer-dated maturities and the tender. But fair enough.

And then to that point, actually, I believe, Lynda, you just said that of the GBP3.3 billion of maturing bonds could be covered from existing cash. Is your plan -- I mean, I've been modeling you as if that's how you will approach your maturities, that you will use cash to pay them down and you won't be refinancing the near-term maturities here. But is that subject to change at all, or is that the plan that you're sticking to for the time being?

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Lynda Heywood, Tesco PLC - Group Treasurer [6]

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I don't think we'd ever give a completely firm view on something like that, because we obviously want to keep our options open. But the point is that we could repay our bonds from the cash we have, which leads us in a very strong position. It means that we can look at where we are at any point in time and decide what to do. But our stated objective is to repay debt as it falls due.

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Alan Stewart, Tesco PLC - CFO [7]

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What I'd add, Rebecca, is that when we look at the balance sheet, we are wanting to use cash which is surplus. And as our business becomes stronger and the recovery becomes clearer -- and that's something we're very firmly in the perspective today that that's what we're seeing -- then the use of the cash that's on our balance sheet becomes a bigger question for us.

We're also conscious that some of the ratings metrics look at gross debt; some look at net debt; and we're wanting to make sure that there's a recognition and an improvement in metrics wherever it's appropriate.

One thing I did say, and it's worth saying here, is that we can now see, we believe, a clear path to investment grade metrics. Not for us to judge whether we are investment grade, but the metrics we can see a clear path to those.

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Rebecca Clements, Fidelity International - Analyst [8]

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And I assume that those metrics -- you're looking at that as well as a -- including some sort of gross debt reduction with that cash, at least in the sort of near term.

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Alan Stewart, Tesco PLC - CFO [9]

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That's one of the metrics which when you work through it becomes potentially one of the pinch points than others.

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Rebecca Clements, Fidelity International - Analyst [10]

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Okay. And then lastly for me, I realized that to date you've done whatever kind of property transactions you can in terms of unwinding and repurchasing properties, but that a lot of them just weren't economically feasible or didn't make sense. Has there been any change there? Or is it still pretty difficult to find property transactions you can do that make economic sense?

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Alan Stewart, Tesco PLC - CFO [11]

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No, you're right. They've always been more situation-specific. And it needs the owner or the joint venture holder on the other side to be willing to sell to us at a price which is economically the right one for us. With more than 50% of the property in the UK now freehold, we feel that we've made really good progress.

There are a relatively small number of properties that we can see ourselves buying back in the second half of this year. Not a very significant number, around GBP135 million from memory, would be what we'd be expending on those, with a low-single-digit reduction in the lease cost of them. And those we can see coming down.

Beyond that, we remain just -- if there's an opportunity, then we will take it. But having made significant progress over the last two years, really three years since we started -- but really two years since we very actively targeted this -- we are comfortable with where we are, but it will be situation-specific.

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Rebecca Clements, Fidelity International - Analyst [12]

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Okay, thank you.

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Operator [13]

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Toby Hunston, Insight Investment.

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Toby Hunston, Insight Investment - Analyst [14]

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Just if I could follow up on the pension question and that slide that you put in. Could you talk about -- in the report, you talk about going from a gilt-based to a [court reform] based discount rate. But if I look back, you had a 2.5% discount rate at February when 20-year gilts were at 1.7%. So I'm just wondering what exactly was that 2.5% derived from, because it's obviously not just straight 20-year gilts. And, therefore, why does the discount rate now step up because you're shifting to this new system?

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Alan Stewart, Tesco PLC - CFO [15]

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Yes, Toby -- sorry, Tony, was it?

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Toby Hunston, Insight Investment - Analyst [16]

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Toby it is, yes.

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Alan Stewart, Tesco PLC - CFO [17]

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Toby. I thought you said Toby, but I've written down Tony. Toby, the -- we're getting into quite an esoteric area. But the way that the -- we look at this is that the standard says, for IAS 19, use a corporate bond rate to discount your liabilities appropriate to when those liabilities fall due. So it's essentially a time and cash weighted rate which is then used to discount the liabilities. Previously we've used a -- the gilts with an element of corporate bond margin on top of that for a risk premium. But we just followed the gilt's curve.

Now, when we've looked at how we actually expect corporate bonds -- and this is where the developing market practice is -- where you actually -- when you look at what you think corporate bonds in this very long-dated world will -- how they will actually behave and how investors value them. If the rate doesn't follow the gilt curve as it is predicted by the market, (technical difficulty) market where there's small uplift in -- for a risk -- a corporate premium, it actually is much more likely to follow an increasing return for increasing time.

That's the way that -- so what we've done is we've taken the 30-year gilt and we've actually projected -- sorry, the 30-year corporate bond -- and projected that flat forward for the remainder of the curve. When you apply that to our weighted by volume and time liabilities in the pension scheme, you get the delta which we are now getting at the 2.8% compared to the 2.5%. So the 2.5% was never directly reference to gilts, but it was built off the gilts.

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Toby Hunston, Insight Investment - Analyst [18]

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Okay. Okay, thanks for that.

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Alan Stewart, Tesco PLC - CFO [19]

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But I would stress that this is an accounting measure and we come back to what we've agreed with the trustees. They look at the actuarial measure, which is at GBP3 billion compared to the GBP2.75 billion three years ago. And against that, we've (technical difficulty) agreement to fund at GBP285 million per annum, which is GBP15 million higher than the previously agreed figure. None of the rest of our framework that we agreed to years ago changed as a result of the triennial valuation.

And the final element, just to repeat, is that 55 -- only 55% of the reduction in the pension deficit was a result of the change in methodology. The other 45% was because of, if you like, real factors which the scheme experienced, mortality table update and asset return.

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Toby Hunston, Insight Investment - Analyst [20]

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Okay. And on the mortality table update -- because obviously it seems counterintuitive when generally life expectancies are going up, for you to bring them down for this. So why was it that you weren't using the general table before?

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Alan Stewart, Tesco PLC - CFO [21]

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Well, we were. And what happens in the triennial valuation -- and this is, again, generally, almost without exception, across all companies -- is that the -- annually, the government publishes mortality tables which are updated annually. Every three years the trustees look to the most recent published -- and the actuary advising the trustees -- look to the most recently published government tables and update from where they were three years before.

What's happened in the last three years is that the rate of increase in life expectancy is now slower than the rate of increase expected three years ago. So, people were expect -- are still expected to live longer, but they're just -- they're not expected to live quite as much longer as they were three years ago.

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Toby Hunston, Insight Investment - Analyst [22]

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Right, okay.

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Alan Stewart, Tesco PLC - CFO [23]

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I'm not sure if that's good news for any of us, but that's where these external tables show it. So it's just standard practice that they are updated every three years off the latest official tables.

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Toby Hunston, Insight Investment - Analyst [24]

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Okay. And then just a final one in terms of sort of use of cash that you generate. Obviously the dividend has come back in, but I was just wondering where you see the waterfall in terms of property buybacks and debt tenders versus dividend, CapEx investing in the business, where we should see property buybacks and specifically tenders.

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Alan Stewart, Tesco PLC - CFO [25]

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Right. Well, our thinking around that -- and this links back to partly why we've put in a refined alternative profit measure in the accounting speak, which is our free cash flow. That really is after everything we've done. So we've got a very clear initiative in respect of property to generate value from our property, the air rights being a key example. And this is the value from surface property. This is not sale and leaseback, as you might have seen us do in the past, just to be absolutely clear on that. And we're generating value from our property estate, and we generated significant value. That's part of the cash that we would want to get from our business and our assets.

We will then look to property buybacks if they make sense. Other than what I've highlighted, there's really nothing that we can see now that we would be wanting to spend money on. And that's partly a function of the returns that we see it. So we've seen property continue to attract quite high interest from investors, and that's partly because of the yield which it gives.

Equally, we think that, in future, that doesn't mean that there won't be opportunities, but right now we think that we're -- and we've done what we need to in terms of the property buyback.

As regards the dividend and the free cash available, we are focused on the -- on generating free cash. We see that free cash as being able to be used to satisfy the overall business needs. Not only the CapEx; we've guided to the GBP1.1 billion to GBP1.4 billion range, with GBP1.1 billion this year.

And then, over time, when we get to an appropriate capital structure -- and clearly implicit, in my mind, an appropriate capital structure includes investment grade credit rating; not for us to give, but for us to ensure that the metrics -- ensure that that's satisfied. Then we will look to use this cash as necessary.

As regards the specifics about bonds, we -- as we become, if you like, a more normal business, we look to more normal active management of our liabilities in line with the (technical difficulty) size and the cost of those liabilities. But that's not to say that we won't continue to look at reducing our interest costs where we have surplus cash.

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Toby Hunston, Insight Investment - Analyst [26]

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Okay. Thanks very much.

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Operator [27]

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[Karen Santoni], BNP Paribas.

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Unidentified Analyst [28]

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Just three questions from me. Alan, could you just tell me what the gross pension deficit is? And then on the second question, any thoughts around IFRS 16, how you intend to implement this? Taking it in the basic sense, you probably won't be able to use your 7% discount rate and benefit from the break clause discounting methodology that you use.

And then this might be a better question for the actuaries, but I'll give it a go. Why are the 2016 tables more appropriate for Tesco's scheme instead of the 2014, given that some of your corporate peers have not adopted the 2016 tables?

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Alan Stewart, Tesco PLC - CFO [29]

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So, in respect of the gross IAS 19 pension deficit is GBP2.9 billion. The net is the GBP2.4 billion. So we've got GBP500 million of the deferred tax assets, which is linked to the relief of debt on the deficit payment as we make it from an income tax or tax payable perspective.

As regards IFRS 16, we continue to evaluate it. We've got somewhere between 8,000 and 9,000 leases that we need to work through, and we are well advanced in that. And when we are fully worked through all of the complexities of those leases from a capturing perspective, we'll then work out and evaluate the different adoption techniques.

We're very conscious that next year is the comparator for us with adoption needed and the 2019-20 year. As and when we can update for (technical difficulty), we will update. And we obviously also want to be starting an engagement with the rating agencies to understand how they will be factoring this into their models.

As regards the break clause, I understand what you're saying. What we do put in our disclosure, certainly in our year-end tables, is the rentals which exist through to the end of the lease beyond the break clause. But the standard requires us to take it to the break clause, and that's what we put into our numbers. And then we'll work out what the direct discount rate is based off the different adoption methodologies done by IFRS 16.

Third element question relating to the tables. I can't answer for other people. What I do know is our practice and our trustees' practice has been every three years to use the latest tables. They are the latest view on UK life expectancy; and therefore, for me, why wouldn't you take the latest view on UK life expectancy?

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Unidentified Analyst [30]

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I was just wondering if there was anything specific that drove you to do that, but that's fine. I just wanted to follow-up on --

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Alan Stewart, Tesco PLC - CFO [31]

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(multiple speakers) It's consistency. Consistency is the only reason.

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Unidentified Analyst [32]

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Okay.

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Alan Stewart, Tesco PLC - CFO [33]

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We -- yes.

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Unidentified Analyst [34]

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I just wanted to follow up on the pension. I'm just looking for the gross obligation. I'm not looking for stuff after net tax. I just want the gross obligation, if that wasn't clear.

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Alan Stewart, Tesco PLC - CFO [35]

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Okay. What -- oh, gosh. The assets and liabilities in the scheme. I'm just looking to the detail. So, as at the -- I'm just -- sorry. I'm not sure if we have disclosed that as at the half year. As at the end of the year, I know they are disclosed. Can we come back to you on that?

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Unidentified Analyst [36]

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No problem.

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Alan Stewart, Tesco PLC - CFO [37]

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But -- yes, and I understand the question. Clearly there is a large -- as I said, there's a large asset and liability in there.

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Unidentified Analyst [38]

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Thank you.

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Operator [39]

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[Graham Julius, Commerzbank].

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Unidentified Analyst [40]

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Well done on the results. A lot of hard work must have gone into that. You just touched on it this morning, but the TESSCO Bank obviously being very prudently managed and making a meaningful contribution. Could you remind me what you see as the overall benefits to the retailing business of continuing with the bank?

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Alan Stewart, Tesco PLC - CFO [41]

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Yes, certainly. And I think the -- what we see very clearly is that the Tesco Bank sees itself as the bank for Tesco customers. So if you are a customer at Tesco, then you are a potential customer for the bank, and it's as simple and as clear as that.

If we then look at the amount of money that customers who are customers of somewhere other than Tesco retail -- whether they are a Tesco Bank customer or, indeed, a Tesco mobile customer -- how much they spend in Tesco retail, we find that there is a significant uplift in terms of the average spend on a monthly basis from a customer who we engage with in more than one of those areas. And interestingly, if you then take all three of them, you get to a much stronger loyalty relationship.

So what we see is that if you are (technical difficulty) Tesco business system, the ecosystem more widely, you are more loyal to us. And that is something which we definitely see. So the benefit from a customer is they get, for instance, Clubcard points on their banking transactions. They have a credit card which they can earn Clubcard points on when they spend it.

And from a business perspective, from the way you asked the question, Graham, we have a more loyal customer who spends more money with us.

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Unidentified Analyst [42]

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Thank you. Very interesting, thanks.

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Operator [43]

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And there are no more questions in queue for the moment. (Operator Instructions). And as there are no questions in queue, I would like to return the conference call to the speakers.

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Alan Stewart, Tesco PLC - CFO [44]

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Great. Thank you very much. Thank you, everybody, and thank you for your time today. We'll -- Lynda will follow up on that one question. And if you have any more, then you know where she is. Very happy to answer any questions. Thanks again for your time.

We're encouraged by the progress we've made. We've made, we believe, significant progress towards (technical difficulty) of the balance sheet. We believe the pension trustee agreement and the confirmation of the deficit funding at pretty much the same levels as before is an important part of the confirmation and the predictability on cash flow.

We've strengthened the balance sheet. We've reduced debt. We're increasing the profitability, and we've made good progress on our debt metrics. And we believe we are well on track for our 2.5% to 4% operating margin by the 2019-20 financial year.

Thank you very much. Look forward to talking to you, if not before then, at the full-year results in April.

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Operator [45]

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Ladies and gentlemen, this concludes today's conference call. Thank you very much for attending. You may now disconnect your lines.