Hargreaves Lansdown

Marks & Spencer Group plc (MKS) Ordinary 25p

Sell: 544.50pBuy: 545.00p02.00p (0.37%)Ex-dividend
FTSE 1000.33%
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HL comment (20 May 2015)

With its full year figures, which revealed underlying profits up 6% to £661m, on flat sales of £10.3bn, M&S has announced an additional £150m return of capital to shareholders, on top of the ordinary dividend. The final payment is raised 7.4% to 11.6p, making the full year dividend 18p, up 5.9%.

Early market reaction to these results has been modest, with the shares a few pence lower.

Highlights:
  • Food business outperformed the difficult UK grocery market. 62 new stores performed ahead of plan.
  • General Merchandise (GM) disappointed on sales, but delivered a strong gross margin increase.
  • GM sales improved toward the end of the year, with M&S.com recovering from an earlier period of disruption around a major website refresh.
  • M&S International profit fell 25% to £92m, hit by macro-economic troubles in Middle East and Europe.
  • Capital Expenditure dropped by £183m to £527m. Free cash flow, before dividends, rose £96m to £524m.

Details:
M&S say that their differentiated Food offer has delivered strong sales against a challenging market backdrop. They intend to open 200-250 new Simply Food stores over the next three years, with Food space rising around 4.5% this year. M&S Food has now delivered 22 consecutive quarters of like for like (LFL) sales growth, helped by refreshing around a quarter of the entire range over the last year.

General Merchandise had a tougher time, with sales coming in below plan, down 2.5%, or -3.1% on a LFL basis. M&S only predict modest growth in this division in the near term, but they expect the benefits of the systems investments already made and improved sourcing arrangements to drive margins ahead.

Marksandspencer.com performed badly over the year as a whole, with sales down 2%, in sharp contrast to most retailers' online divisions. Performance improved as the year progressed, returning to growth in Q4, by which point traffic across the site was registering double digit growth.

Internationally, M&S has struggled, with the weak Euro and a difficult Middle East region, which are continuing to impact the business into the current year. M&S remain convinced of the longer term growth opportunities for the brand in a number of overseas markets.

M&S has spent the last few years investing heavily into its operational systems to create a modern, multi-channel retail business, capable of competing in the rapidly changing retail environment of today. This is now largely complete and as the investment costs recede M&S expect to generate more cash flow and intend to return this to shareholders via a progressive dividend policy, based around roughly 2x cover, with additional payments returned initially via share buybacks.

Looking forward:
M&S are guiding toward gross margin gains of 150-200bp in the GM division, flat to slightly positive Food gross margins, all offset to some degree by a 4% operating cost increase in the current year. Capex will be similar to last year, in the £500-550m range. No net new space will be allocated to GM, Food will add c. 4.5% and International will add 5%.

Commenting on the outlook, CEO Mark Bolland and Chairman Robert Swannell observed that the group had performed well against three of its four key targets, with GM sales growth the obvious laggard. The business is stronger and more agile, better placed to generate free cash flow. Having returned the GM business to growth in the final quarter, M&S is now focused on the delivery of strategy and improving shareholder returns.

Read more share research from Hargreaves Lansdown

Our view:
Improving free cash flow is enabling M&S to take a more generous approach to shareholder returns, with a new commitment to progressive dividends accompanied by regular additional returns of capital announced with the 2015 final results.

M&S Chief Executive Mark Bolland is not out of the woods yet, but he must be thinking that he caught a glimpse of the meadow when he saw the pick-up in performance in the final quarter of FY 2015. His tenure has seen a protracted period of difficult trading for the General Merchandise business, which includes the core clothing ranges and the M&S Home offering.

Food has been a different story, with twenty-two consecutive quarters of LFL growth and a significant expansion of the store estate, as Simply Food has spread out across the UK.

The website has been a real laggard of late though, after M&S botched the transition to a new, company designed and operated platform, having previously outsourced much of their ecommerce operation to Amazon.

All the while, Mr Bolland was busily investing into modernising systems and more sophisticated sourcing to try and maximise the value of M&S’s £10bn p.a. sales base. That took time and cost a lot of money, depressing free cash flow as the spending took place.

Now, M&S hope to reap the reward. So far, they can't look to the top line with confidence, because outside of the foods business, progress is pedestrian at best. But the margins that M&S are set to generate are looking livelier, as the benefits of the new systems, sourcing and distribution networks kick in.

Over the next few years, this should support shareholder returns, with the announcement of a £150m buyback for FY 2016 the first of an intended regular, additional return of capital, enabled by M&S having moved out of the heavy capex phase of its investment programme.

Our concern for Marks and Spencer though is longer term in nature. When it meets its own expectations, the group is pretty good at what it does, but what it does not do is attract a younger shopper. If M&S was the place that Mum dragged you to buy your undies and school uniform, it's probably not the place you will choose to buy clothes as an adult. But thankfully, Home and Food don't seem to suffer from that association. M&S has ceded a lot of market share in clothing over the years, as newer shoppers have turned to more fashionable rivals, whilst Primark and other discounters have captured market share, hand over fist, too.

With the benefit of stronger cash flow, M&S has some breathing room to try and work out how to bring the customers it lost over the last decade, back into the stores. At current levels, the dividend of 18p per share represents a yield of 2.7% (variable and not guaranteed), somewhat below the market average. The shares trade on a consensus forward PE ratio of around 16.6x, according to Bloomberg which is around a 33% premium to their longer term average rating, suggesting there may already be a degree of optimism built into the market's expectations for M&S moving forward although there are no guarantees.

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