Marks and Spencer's half year results reveal better than expected gross margins, but weaker than expected General Merchandise (GM) sales. Overall sales were up 1.4% to £5.0bn, with Food once again outperforming GM. Underlying operating profit and earnings per share rose by 6.1% to £284.0m and 4.9% to 14.1p, respectively, on the back of the higher margins. This enabled the interim dividend to be lifted by 6.3% to 6.8p. The shares rose by around 3% in early morning trading.
Food sales were up 3.3%, with like-for-like (LFL) sales 0.2% ahead. Despite the on-going competition and deflation in the food sector, M&S outperformed the market by c.3%, and has now seen 24 consecutive quarters of LFL growth. 32 Simply Food stores were opened in the first half with sales performance ahead of expectations.
General Merchandise sales were down 0.4% and LFL sales fell by 1.2%, with sales in Q2 impacted by lower promotional activity. Online sales grew strongly (+34.2%), but this reflects a very weak comparative. M&S experienced teething problems following its new website launch last year, which caused online sales to fall by 6.3% in the prior half year. Gross margins rose by 285 basis points (bps) to 56.6%, driven by sourcing gains and lower discounting. Full year gross margin guidance has been raised to +200 to 250bps (previous guidance: +150 to +200 bps).
International sales were down 0.9% on a constant currency basis (down 5.1% on reported currency). Sales in Asian priority markets such as India and Greater China continued to grow, but Euro currency pressures impacted profitability.
Despite some improvement in consumer confidence, market conditions continue to be challenging in both the UK and International markets. The group's short term priorities remain the same: Food sales growth, General Merchandise gross margin improvement, improved General Merchandise performance and strong cash generation.
Marks and Spencer's CEO, Marc Bolland, has invested heavily over recent years to try to improve profits at General Merchandise. This has entailed modernising systems and using more sophisticated sourcing to try and maximise the value of its £10bn per annum sales base. This 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. This is supporting cash flows and enabling the group to reward shareholders through dividends and share buybacks.
Our concern for Marks and Spencer though is longer term in nature. 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 (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, or cheaper outlets such as Primark.
With the benefit of stronger cash flow, M&S has some breathing room to try and work out how to bring back the customers it lost over the last decade. At current levels, the shares offer a prospective yield of 3.6% (variable and not guaranteed), and trade on a forward price to earnings ratio of around 14.1x, compared to a long run average of 12.1x.
All yield figures are variable and not guaranteed.