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Marks and Spencer - new direction?

Steve Clayton | 25 May 2016 | A A A
Marks and Spencer - new direction?

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Marks & Spencer Group plc Ordinary 1p

Sell: 133.20 | Buy: 133.40 | Change -1.75 (-1.30%)
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Full-year results from M&S held few surprises, a market-beating food result, accompanied by lacklustre clothing sales. The problem has been around for years, and too many people, especially younger ones, instinctively regard M&S as a great place for a tasty treat, but they would not dream of buying the clothes.

New CEO Steve Rowe is a lifetime M&S staffer, generally credited with driving the hugely successful foods business in recent years. Before he was elevated to the top job he was tasked with trying to breathe new life into the Clothing and Home division, and despite his new role has retained personal control of that division. As a result, perhaps even more than any other M&S boss in recent years, Steve Rowe will be judged by the group's Clothing like-for-like (LFL) sales.

Accompanying the results, Mr Rowe has announced the first elements of a strategic review, designed to turn the Clothing and Home business around, whilst maintaining the pace in Foods. The key element is a shift toward 'Everyday Low Pricing'.

But the immediate impact of changing the group's direction will be to hit profits. M&S sugar the pill by announcing a special dividend of £75m, or 4.6p per share, to be paid with the final dividend for the year just ended and made affordable by a roughly equal reduction in the planned level of capital expenditure. The market took a dim view, pushing the shares sharply lower on the news.

What's changing?

M&S says its Clothing & Home sales performance has been unsatisfactory for years. It recognises a need to be more stylish and contemporary, with a focus on the essentials, not the outlandish. M&S intends to continuously refresh these everyday basics to stay current and competitive. It recognises the need to regain its reputation for unrivalled quality, through fit, fabric and finish.

Prices need to come down and M&S will invest in everyday pricing, pull back from promotions and concentrate on making the entry level price in their 'Good, Better, Best' strategy more attractive. Where they do run promotions, they want to use the data from the new Sparks loyalty card to better target them.

The range will be reduced, starting with Autumn/Winter, to try and make it easier to shop and to allow all stores to carry a strong range, regardless of store size. Duplication (how many beige slacks does one store need?) will be cut and sub-brands re-examined. A smaller, deeper range should reduce out-of-stocks, allowing customers to find their size first time, more often.

Delivering a recovery in Clothing and Home will not be quick and customers will take time to notice changes and alter their behaviours. M&S believe the changes are right for the future, but will hit profits near-term.

Fast forward food

The Food business has performed well for years, largely side-stepping the broader supermarket sectors problems, because of its distinctive focus and unparalleled quality proposition. M&S is finding its new Simply Food stores are performing ahead of plan and will increase the pace of openings to 100 per annum for the next few years. With shoppers increasingly making more frequent, smaller trips, M&S believes the Simply Food offer is perfectly positioned.

The year ahead

The International division had a difficult year and M&S sees little change here. Food is set to see space rise by around 5% and margins are likely to be flat, given the competitive conditions here. Clothing and Home have been making good margin gains recently, even if sales volumes have been poor. These buying gains are set to continue, but are now expected to be absorbed by a currency headwind and the cost of price investment.

Operating costs look set to rise by 3.5%, which is likely to be a little ahead of sales growth, as the company invests in more staff to boost service and picks up higher rents in the Food business. Overall, M&S sees an "adverse impact" on profits in the near term, a price seen as a worthwhile investment if it lays the ground for a longer-term recovery in the Clothing and Home division.

And further beyond

There is a review of the store estate underway, which is unlikely to conclude M&S needs more clothing selling space. The new focus on a more concentrated range suggests a need for less not more space, so disposals or downsizing of stores could be on the cards. The shape of the International business is also under review, and the exposure to Europe and the Middle East are likely to be under the microscope. M&S also says it is reviewing its "organisation", which could relate to central costs.

Our view

There is little in this review we haven't seen before. A refocus on the price architecture is hardly news. The step-back away from promotions is painful but necessary and slimming the range down makes sense too. But M&S needs to fundamentally change how people perceive it, and there is no sense in today's statement that they are about to make that shift. The special dividend is nice to have, but with profits falling in the current year, the cover on the ordinary dividend is coming under pressure.

The yield is undeniably attractive, but can only be relied upon if Mr Rowe can turn the ship around and the evidence for that will take time to become clear.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.