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Marks & Spencer - slightly better results, but work to do

Nicholas Hyett | 23 May 2018 | A A A
Marks & Spencer - slightly better results, but work to do

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Marks & Spencer Group plc Ordinary 1p

Sell: 180.45 | Buy: 180.75 | Change 0.20 (0.11%)
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Full year revenues ticked up 0.7% at Marks & Spencer, driven by the opening of new M&S Simply Food stores. UK like-for-like (LFL) sales fell 0.9%, with performance deteriorating over the course of the year.

Underlying operating profit was down 2.9%, with results supported by an exceptional international performance, while reported profits fell 62.1% as transformation costs weighed heavily on the group.

The ordinary dividend remains unchanged at 18.7p for the full year, although no special dividend was paid this year.

The shares rose 5.4% in early trading.

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Our view

M&S's problems are multiplying.

Increasing online competition, and the high cost of maintaining a high street presence are hitting sales and profit in the Clothing & Home business. The Foods business, previously a shining light, has also stumbled as input costs rise and online retailing penetrates the supermarket sector.

Meanwhile the economic climate is tough. UK consumer spending power and high street footfall, two crucial factors for a bricks and mortar retail business, are both weak. M&S is hardly alone facing that headwind, but the fact other high street giants are falling left and right isn’t much consolation for investors.

Even the weather has been against the group. An unseasonably warm October impacted results in the Christmas period, and the ‘Beast from the East’ buffeted spring sales.

Nonetheless, it would be foolish to attribute M&S' decline to bad luck. Clothing & Home LFL sales have been going backwards for years.

We think CEO Steve Rowe will have his work cut out to 'make M&S special again'. His words might be a bit clichéd these days but they do encapsulate the challenge of breathing new life into a business that has fallen flat after all those years of magic and sparkle.

Phase 1 of the turnaround got the ball rolling with the reduction in UK and international store numbers, with a total of 100 now earmarked for closure. Cost savings and improving supply chains are pretty standard goals, but the targets for increased digital capacity catch the eye. In the medium term, M&S wants to generate a third of Clothing & Home sales online.

This may be ambitious, but given the way retail is going, we feel it's a worthy goal. It just feels a bit late.

The difficulties in the Food business mean that while new stores will still be opening, the emphasis is shifting to improving those that are up and running already. This seems sensible, but it does put the pressure on Clothing & Home to reverse its recent poor performances.

M&S shares trade on 10.8 times forecast earnings per share, a little below its longer term average, and offers a prospective yield of 6.4%.

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Full Year Results

Revenues in Food rose 3.9% to £5.9bn following the opening of 62 new Simply Food stores, with LFL sales down 0.3%. Gross margins fell 1.4 percentage points, as weak sterling continued to increase the cost of stock.

Clothing & Home sales fell 1.4% to £3.7bn, with LFL sales down 1.9%. Gross margins were in line with expectations, improving by 0.5 percentage points thanks to reduced discounting. Online sales rose 5.2%.

The International business saw sales fall 7.9% to £1.1bn, but profits jumped 110% to £135.2m as the group exited loss making markets and enjoyed a currency boost in several retained markets.

Full year operating costs in the UK rose 1.8%, to £3.5bn, with staff and warehousing/distribution costs driving the increase. That was partially offset by a 6.8% fall in marketing costs compared to the prior year.

M&S reported £514m in exceptional costs in the year, including £321m relating to the reduction in size of the store estate. The group expects to book a further £150m in costs relating to store closures in the future.

Free cash flow was 29% below the previous year at £417.5m, following substantial cash transformation costs. However, this still comfortably covers the ordinary dividend, with surplus cash reducing debt by 5.5% to £1.8bn.

Sales space is expected to be 5% lower in Clothing & Home next year, supporting a 0.5 percentage point improvement in gross margins. Food sales space is expected to be broadly unchanged as new Simply Food stores offset closures of Full Line stores. UK costs are expected to be 1% lower than this year, with capital expenditure of £350-400m.

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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.

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