By James Davey and Neil Maidment
LONDON (Reuters) - Price cuts and better service helped Tesco (L:TSCO) to win back shoppers in the first quarter of its financial year, Britain's biggest retailer said on Friday, suggesting new boss Dave Lewis's turnaround plan is starting to bear fruit.
Tesco has had a horrendous 18 months, with competition from fast-growing discounters Aldi and Lidl compounded by an accounting scandal that drove it to a record annual loss.
But former Unilever (L:ULVR) executive Lewis has cut prices on popular grocery brands, improved product availability and put more staff in store.
Sales at British shops open for more than a year fell 1.3 percent in the 13 weeks to May 30, Tesco said, partly reflecting a drop in food prices across the industry.
But that was better than analysts' forecasts for a fall of 1.6-3.0 percent, an improvement on the previous quarter, and also better than recent figures from major rivals Asda (N:WMT), J Sainsbury (L:SBRY) and Wm Morrison (L:MRW).
Tesco also said 180,000 more customers shopped at its UK stores in the quarter, with the volume of goods sold up 1.4 percent on a like-for-like basis and transactions up 1.3 percent.
"Stemming the defection of consumers is the first, and arguably the most important, battle to be won," said Neil Saunders, managing director of retail researchers Conlumino.
Tesco's shares, down 21 percent over the last year, rose as much as 4.4 percent to a one month high of 227.35 pence.
While welcoming the improvements, however, some investors cautioned Tesco faced a battle to continue its recovery in the teeth of an industry price war.
"The price driven competition we are seeing across UK food retailing has made a tough business tougher," Richard Marwood, senior investment manager at AXA Investment Managers, one of Tesco's 30 largest shareholders, told Reuters.
RIGHT DIRECTION
All of Britain's big four grocers are trying to recover ground lost to Aldi and Lidl by launching multi-million pound price cuts. They are also dealing with commodity-led deflation and are having to rethink strategies as customer habits move away from big weekly shops at large out of town stores.
Lewis is cutting costs and selling assets as he seeks to reduce Tesco's debts, regain its investment-grade credit rating and re-build its credibility. Prices are also coming down, with 300 products reduced in the first quarter alone, funded in part by a shake-up of its supplier base and a focus on best sellers.
Tesco said industry data showed its prices over the period were four percent cheaper than its main British rivals.
"Whilst the market is still challenging and volatility is likely to remain a feature of short-term performance, these ... results represent another step in the right direction," said Lewis, who took the helm in September.
After decades of dominance Tesco reported a 2014-15 underlying trading profit of 1.4 billion pounds ($2.2 billion) in April, down nearly 60 percent on the year before, and warned it might not match that level this year.
Lewis told analysts on Friday the consensus forecast for a 1.4 billion pound trading profit this year was an "aspiration", cautiously pointing to expectations for deflation to continue alongside short-term disruption as Tesco changes its trading approach.
"We believe this comment should imply that Tesco is making losses once again in the UK in the first half and that it may struggle to reach consensus profitability goals for FY15/16," Espirito Santo analysts said.
The results came ahead of Tesco's annual shareholder meeting, attended by around 1,000 investors looking for a first chance to quiz the board directly since last year's accounting scandal, which related to wrongly booked payments from suppliers.
Shareholders could revolt over a 1.2 million pound payoff to ex-CEO Philip Clarke and a 1 million pound payout to ex-finance chief Laurie McIlwee, who resigned in April last year.
Tesco, which also reported a slowdown in the sales decline at its Asian business, declined to comment on asset disposals.
The group is selling its data business Dunnhumby and, according to sources familiar with the matter, has hired HSBC (L:HSBA) to explore the $6 billion sale of its South Korean unit, Tesco's biggest business outside Britain.