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🚨September 22 2014:
During its final preparations for the forthcoming interim results, Tesco has identified an overstatement of its expected profit for the half year, principally due to the accelerated recognition of commercial income and delayed accrual of costs.
On the basis of preliminary investigations in to the UK food business, the Board believes that the guidance issued on 29 August 2014 for the Group profits for the six months to 23 August 2014 was overstated by an estimated £250m. Some of this impact includes in-year timing differences. Work is ongoing to establish the extent of these issues and what impact they will have on the full year.
The Board has asked Deloitte to undertake an independent and comprehensive review of these issues, working closely with Freshfields, the Group’s external legal advisers.
🚨August 21 2025:
In preparation for the Group’s year end results for the financial year ending 31 August 2025, a current financial review has identified an overstatement of around £30m of expected Headline trading profit in North America. This overstatement is largely due to the accelerated recognition of supplier income in the North America division.
WHSmith now expects Headline trading profit from the North America division for the financial year ending 31 August 2025 to be approximately £25m, down from previous market expectations of approximately £55m.
As a result, the Group expects full year Headline profit before tax and non-underlying items to be in the region of £110m.
The Board has instructed Deloitte to undertake an independent and comprehensive review.
There’s a lot that’s familiar about WHSmith’s warning today that it has exaggerated full-year profit by around £30mn, “largely” from a North American division that does sales of just over £400mn. As well as the phrase “accelerated recognition of commercial income” and the Deloitte-led “comprehensive review” rhyming with Tesco’s 2014 alert, there’s a similar lack of information on what exactly has happened.
With that in mind we can only speculate, starting with the intricacies of accrual accounting. (WHSmith, like Tesco in 2014, is audited by PwC.)
Retailers like Tesco and WHSmith receive income from suppliers in the form of incentives and discounts, which are often based on volumes supplied. The deductions are recognised on a contract-by-contract basis against cost of goods sold, but they’re booked as soon as they arrive rather than when the goods are sold.
Best practice is for retailers to match supplier income deductions to the relevant trading period. If a company chooses to recognise too much supplier income too soon, a gap will open up between the profit-and-loss account’s accrual profit and cash generation. That seems to be what’s happened at WHSmith North America.
Analysts and investors who’ve talked to WHSmith this morning tell us they understand that supplier income for North America was being booked too early. The review will push some percentage of supplier income into future periods. How much, and where exactly it lands, will be up to Deloitte.
Assuming that’s all accurate, the big question is why WHSmith North America had been booking such a huge amount of supplier income in the first place. The division had been expected to deliver approximately £40mn in EBIT this fiscal year, so today’s warning implies an approximately 75 per cent downgrade. Even if all the lost earnings turn up in subsequent years, it still raises doubts over how much anyone can trust historic profitability.
WHSmith entered the US market in October 2018 with the acquisition of InMotion, an airport electronics retailer, then bought travel-shop chain Marshall Retail Group a year later. The two businesses have been put at the centre of the investment case following the recent disposals of its UK high street presence and its FunkyPigeon greetings cards website.
The timing of the pivot was not ideal. Inbound travel to the US has nosedived: the National Travel and Tourism Office reporting that foreign travellers arriving into US airports in July was down 5.1 per cent year on year.
WHSmith Travel sells low-ticket-price convenience products like food, books, souvenirs and phone chargers, which makes it more reliant on passenger volumes than the duty-free and luxury goods chains. It’s not hard to imagine pressure on divisional management to keep delivering like-for-like growth in spite of sharply reduced footfall.
Key airports for WHSmith include Hartfield-Jackson Atlanta and Dulles in Washington DC, with JFK in New York among the recent trophy contract wins in an expansion drive that aims to take a 20 per cent share of the North American market by 2028. Carl Cowling, WHSmith’s CEO, today stuck with that target.
Another thing to consider is the unusual nature of travel retail. It’s high margin thanks to having a captive audience and barriers to entry born of the closed-shop concession bidding process.
Each store has an effective geographical monopoly so the same is true of any product that it awards with a prime position on the shelves:
It’s standard practice in retail for suppliers to pay in kind to have their products displayed prominently. Tesco’s 2014 profit overstatement was partly caused by its practice of invoicing suppliers for shelf promotion, known in industry jargon as gate fees, then setting off these costs against the amounts owed.
Tesco’s problem was that it was charging suppliers gate fees but not doing the promotions. Here’s a relevant bit from the Groceries Code Adjudicator’s 2016 Investigation:
I understand from suppliers that where payment to Tesco for invoiced amounts was agreed, Tesco usually had the right to set off the amounts from suppliers’ trading accounts against payments otherwise due for goods delivered. It is apparent that this arrangement also enabled Tesco to unilaterally deduct money from suppliers’ accounts where invoiced amounts were not agreed.
To be clear, we’ve no idea if WHSmith North America was employing similar promotional methods. In a business where prominence on the shelf has critical importance, it would be odd for it not to use gate fees in some form. Over-reliance on promotional clawbacks might contribute to the wide gap between accrual and cash profit. But that’s all speculation on our part.
For the moment, with the investigation just started, it’s impossible to say what’s going on. Here’s the view of Peel Hunt analysts:
This is a very “fresh” situation and management has literally only uncovered it in the last few days. Therefore, anything resembling guidance for outer years has been withdrawn. What is unclear is whether this is a one-off timing issue for FY25. Management has distanced itself from this notion, which implies that maybe there has been some early recognition of supplier discounts taken from contracts that have long duration. A forensic study remains to be done of all the contracts so that the full extent of the situation can be established and that is unlikely to have been completed until the prelims in November. It leaves forecasting the US a pin sticking exercise . . .
In the wake of Tesco’s 2014 accounting scandal the share price took nearly 10 years to reclaim its previous level.
Facing similar uncertainties, WHSmith’s prospects for a quick bounceback don’t look a whole lot better:
