Tesco the world's third-biggest retailer, posted first-half profit towards the top end of forecasts and said it was seeing a gradual economic recovery with shoppers starting to treat themselves again.
The supermarket group also said on Tuesday growth in its core British market had converged with rivals in recent weeks, but its second-quarter performance was towards the bottom end of forecasts as a prolonged rise in food prices comes to an end.
Tesco's growth rate has been lagging its main competitors in Britain due, in part, to its exposure to non-food products which have been hit harder than groceries in the recession.
"Solid, but not inspiring," said BofA-Merrill Lynch analyst John Kershaw of the first-half performance.
Tesco, which runs over 4,300 shops in 14 countries, said profit before tax and one-off items rose 8.6 percent to 1.57 billion pounds ($2.5 billion) in the six months to Aug. 29, helped by deals last year to buy a store chain in South Korea and to take full control of a banking joint venture.
That was the smallest increase for 10 years as interest costs climbed because of the debt taken on to pay for the deals, but towards the top end of analysts' forecast range of 1.31-1.62 billion pounds, according to a Reuters poll of 12.
Sales increased 9.3 percent to 27.8 billion pounds, and the interim dividend was lifted 9 percent to 3.89 pence.
"We're seeing signs of a gradual improvement (in the world economy)," chief executive Terry Leahy told Reuters, adding that shoppers were starting to treat themselves again, with sales of organic foods, ready meals and premium "Finest" products rising.
Like-for-like sales of non-food goods had also returned to growth, he said, adding to recent evidence of improving confidence among shoppers.
Tesco shares, which have outperformed British rivals Sainsbury and Morrison this year on hopes of a recovery in non-food spending, were down 1 percent at 387.8 pence.
Grocers have fared better than many retailers in the recession, thanks to their focus on selling essential goods and a prolonged period of rising food prices.
Retail sales in the European Union fell 0.3 percent in August from July, with the drop in non-food sales more than offsetting demand for groceries.
But food inflation has fallen recently as commodities prices have eased, contributing to profit warnings from European and U.S. supermarket chains.
The impact has been delayed in Britain by a weaker pound, but Leahy said food inflation had now slowed to zero, though he also saw little risk of significant deflation.
Tesco said sales in Britain — around two thirds of its total — rose 3.1 percent for stores open at least a year, excluding fuel and VAT sales tax, in the second quarter. That was down from 4.3 percent in the first quarter, due mainly to the lower food inflation, and below analysts' average forecast of 3.4 percent in a Reuters poll.
Sainsbury was expected to post a 5.6 percent rise in underlying sales on Wednesday.
However, Leahy said Tesco's growth had converged with rivals in recent weeks, helped by the relaunch of its Clubcard customer loyalty program in August.
British food maker Northern Foods also reported a drop in food price inflation on Tuesday.
Leahy played down speculation Tesco might buy assets from nationalized British bank Northern Rock or Lloyds Banking Group to speed growth at its banking business. "We're focusing on organic growth," he said.
Tesco shares trade at about 13.4 times forecast earnings, below bigger rival Carrefour on 14.9 and world number one Wal-Mart on 13.8.
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