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M&S - Ocado deal confirmed, but shares fall as dividend cut

George Salmon | 27 February 2019 | A A A
M&S - Ocado deal confirmed, but shares fall as dividend cut

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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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Marks & Spencer has announced a new joint venture with Ocado which will see M&S take a 50% stake in Ocado's UK retail business for £750m.

From September 2020, Ocado will be able to sell M&S branded products. M&S is seeking to raise £600m in a rights issue to fund the deal.

The group also announced its rebasing its dividend, with a 40% cut. That means the final dividend is set to be 7.1p per share.

The shares fell 9% on the news.

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Our view

M&S operates in two segments - Clothing & Home and Food. After doing a stellar job as the supporting act, the 50% joint venture with Ocado means Food is now the headliner.

In principle, the deal is attractive.

While M&S food is well-regarded by the public, the average basket is unlikely to have much more than a bottle of wine, and a couple of posh ready-meals. The convenience market is an attractive niche, but the group has started to bump up against the sides of the tank. To find the next gear, it had to find a way of getting into the weekly big shop.

With an average order size close to £100, Ocado gives M&S the chance to do just that. And there's lots of potential customers out there. Ocado already fulfils 290,000 orders a week, a figure that's been growing at double-digit percentages.

M&S says it can get cost-saving synergies of around £70m after three years, while the two brands should tie nicely together. That should create cross-selling opportunities - good news for both brands.

For all its intuitive appeal, investors shouldn't forget the price. £750m for a business that delivered around £50m of cash profits last year is a hefty sum. Hopefully it can generate the growth this multiple demands. Unfortunately, with the Clothing & Home division facing a cocktail of headwinds, it might have to.

UK consumer confidence is weak, while footfall is further tempered by the rise of online competitors. Together with the high cost of maintaining a high street presence, these factors have seen profits tumble.

CEO Steve Rowe has decided to close stores, reduce spending and increase digital capacity. For the range, the strategy is to go back to basics - with a focus on wearable wardrobe 'must-haves'. There's some signs this plan is working, with online sales bouncing, and the group describing its recent performance as 'steady with some early encouraging signs'.

However, problems in the division are far from resolved, and restructuring a business the size of Marks & Spencer takes significant time, effort and money. With the bulk of the Ocado deal due to be funded by a rights issue, it's hard to see how the significant dividend cut isn't more a function of the painful transition in Clothing & Home.

That cut means the company is set to pay a dividend of 11.2p next year, suggesting a prospective yield of just over 4%.*

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Third quarter trading details (10 January 2019)

Within the UK, the Clothing & Home division is suffering from 'well publicised difficult market conditions' including heightened discounting and lower consumer confidence. Sales dipped 4.8%, which represents a LFL decline of 2.4%. The physical stores suffered from lower footfall, but there was strong growth online, where sales rose 14%.

CEO Steve Rowe said he expects more far reaching changes in range and store development as the year unfolds.

Within UK Food, despite the majority of stores performing well over the Christmas period, over the quarter as a whole LFL sales fell 2.1%. This decline more than offset the effect of new store openings, with total sales down 1.2%.

International revenue fell 15.1%, driven by the sale of the Hong Kong business and store closures. Excluding these effects, revenues fell 1.4% at constant currency largely due to the timing of franchise shipments and investment in improved pricing.

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* this yield has been corrected on 28/02/2018 following an initial error.

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.