By James Davey and Neil Maidment
LONDON (Reuters) - Plunging profits in mainland Europe blew a new hole in Tesco's recovery plan on Wednesday, piling pressure on the world's No.3 retailer as it struggles to reverse market share losses in its main UK market and extricate itself from other foreign failures.
The grocer said first-half trading profit slumped 68 percent in its European division, made up of the Czech Republic, Hungary, Poland, Slovakia and Turkey as well as Ireland, adding to signs of a slowdown in developing markets after a warning from consumer goods group Unilever
That, along with weaker trading in some Asian markets, including previous star-performer Thailand, dragged down Tesco's
"With profits nosediving in Europe and Asia, the foreign markets that once provided a perfect hedge against weak demand at home are now more hurdle than help," said John Ibbotson, director of consultant Retail Vision.
The darling of the retail sector during two decades of uninterrupted earnings growth, Tesco has suffered in recent years from failed attempts to break into the United States and Japan and a costly, still unprofitable, expansion in China.
While it invested abroad, it also neglected Britain, where it still makes over two-thirds of sales, and started losing market share to rivals including Wal-Mart's Asda
Despite being 18 months into a 1 billion pound ($1.6 billion) turnaround plan in Britain, which has included revamping stores, recruiting more staff and new product ranges, the group said sales at UK stores open over a year, excluding fuel and VAT sales tax, were flat in the 13 weeks to August 24.
Though that was at the top end of analysts' expectations and an improvement on a 1 percent decline the previous quarter, it was well below the 2.0 percent rise, excluding fuel, reported by Sainsbury for the 16 weeks to September 28.
Ibbotson said Sainsbury had managed a delicate balancing act which has so far eluded Tesco, with its premium "Taste the Difference" and budget "basics" ranges helping Sainsbury to fend off competition from both the discounters and Waitrose.
COMMITTED TO EUROPE
Tesco, which lags France's Carrefour
That reflected like-for-like sales declines in all ten of its overseas markets and particularly heavy falls in central and eastern Europe, which the company blamed on government austerity measures, rising inflation and high unemployment.
Deutsche Bank analysts said European profits of 55 million pounds were 60 percent below their expectations and predicted analysts' full-year group trading profit estimate would fall 2-4 percent to 3.35-3.45 billion pounds, excluding the benefits from Tesco's move to fold its Chinese business into a state-run firm.
Despite the profit slump, Tesco said it remained committed to its European businesses, which account for about 12.5 percent of group sales. It expects to benefit in the second half from curbing store openings and focusing on stronger-growing convenience store and online markets.
"When the macro economic environment comes back to being a bit more positive and real wages start to grow we'll have very profitable businesses in that region," said chief financial officer Laurie McIlwee, though he said Tesco's business in eastern Turkey, which lacks "critical scale", could see some restructuring.
Chief executive Phil Clarke said there were also signs the turnaround plan in Britain was working, with like-for-like food sales in the second quarter growing 1 percent, clothing sales up 8.6 percent and online grocery sales up 13 percent.
"We're feeling very positive about the changes that we've made and consumers are reacting very well," he said.
Tesco has suffered more from a weak British economy than many rivals because it sells a higher proportion of discretionary non-food goods, like electrical items and homewares, where shoppers have been making the biggest cut backs.
Like other retailers, Tesco and Sainsbury were cautious about signs of economic recovery in Britain. "We can of course see all those encouraging signs from economic indicators but our customers tell us that they still don't have extra money in their pocket," said Sainsbury's commercial director Mike Coupe.
Tesco shares, which have lagged Sainsbury's by 7 percent over the past year, were down 1.9 percent at 1407 GMT (1007 EDT). Sainsbury's were down 1.3 percent. ($1 = 0.6172 British pounds)
(Editing by Mark Potter and Erica Billingham)