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M&S - Profits drop as expected

George Salmon | 24 May 2017 | A A A
M&S - Profits drop as expected

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Marks & Spencer Group plc Ordinary 1p

Sell: 134.35 | Buy: 134.60 | Change -0.30 (-0.22%)
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Profit before tax for 2016/17 is down 64% to £176m, significantly impacted by the charges associated with closing the defined benefit pension scheme and the impact of international closures.

On an underlying basis, profits fell 10.3%, due to the expected decrease in Clothing & Home sales and the increased costs of new space, although the group has delivered a stronger gross margin than had been expected. The shares rose 2.2% after the announcement.

Our View

M&S is in the early stages of a turnaround. CEO Steve Rowe has grand plans to refocus the range and restructure the store estate.

Marks & Spencer has had problems with its clothing division for years. Despite its best efforts, many, especially the younger generations, still find the group's clothing offer unappealing. Vast, empty shops are doing little to improve the company's image, so a change seems sensible.

The group will end up with 60 fewer Clothing & Home stores, and many of the remaining shops will be revamped. The international business is also being shaken up, with the group switching to a franchise model overseas and exiting 10 loss-making territories.

These changes all seem sensible. However, diagnosing the illness and applying the cure are very different things. The changes to the store estate are likely to come with a bill for at least £500m, so special dividends might well be off the table for a while. Putting a halt to specials clearly raises the stakes for Mr Rowe.

Unfortunately for him there are some pretty strong headwinds blowing in the retail sector just now, not least the higher cost of importing textiles as a result of sterling's weakness. The years when 'Made in Britain' tags adorned almost all of its clothes are long gone, so M&S will be affected by this. After some impressive growth in clothing margins in recent years, progress may well be held back going forward.

On a more positive note, the Food division, which generates over 50% of group revenue, has performed strongly in recent years, and further expansion is in the pipeline. There are also rumours around that a partnership with Ocado could be in the offing.

M&S shares now trade at 13.4 times forecast earnings per share, and offer a prospective yield of 4.9%.

Full year results

Over the year, Clothing & Home revenues declined 2.8%, with like-for like sales down 3.4%. LFL sales fell 5.9% in the final quarter of the year, as the December sale and Easter both fell outside the period this year. Against a weak wider clothing market, M&S says its fourth quarter performance means its market share is now stabilising.

Gross margin was up c.105bps year-on-year, helped by a renegotiation of supplier contracts, and the decision to move business to lower duty locations. Margins were also boosted by a reduction in markdown activity, resulting in a 2.7% increase in full price sales.

In Food, like-for-like sales were down 2.1% in Q4, again impacted by the timing of Easter and the December sale. Gross margins dipped 0.25 percentage points, as a result of cost inflation.

Looking ahead, the group is set to open further Simply Food stores at a steady rate, with c.250 more stores planned by 2019/20. Cost inflation could impact margins by up to 0.5 percentage points next year.

M&S.com revenues increased by 4.9%, despite the removal of eight online cyber events.

While there is no repeat of recent special dividends this year, the ordinary full year dividend is held flat at 18.7p per share.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.