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Marks & Spencer - profits down again

George Salmon | 22 May 2019 | A A A
Marks & Spencer - profits down again

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Marks & Spencer Group plc Ordinary 25p

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Store closures and tough trading conditions meant group revenue declined 3% to £10.4bn. Pre-tax profit fell 9.9% to £523.3m, driven by substantial costs relating to store closures.

As previously announced, the final dividend was 25.7% lower at 13.9p.

The shares fell 4.6% following the announcement.

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Our view

With sales falling in both of M&S' core divisions, management are faced with numerous problems.

Clothing & Home, the bedrock on which the 135-year old business is built, is suffering from increasing online competition and the high cost of maintaining a high street presence.

CEO Steve Rowe is the man with a plan. Some of his measures fall into the self-help category. Think store closures, reduced spending and higher digital capacity. For the clothes themselves, the strategy is to produce more fashionable fits and wardrobe 'must-haves', while reducing unnecessary duplication within the range to increase buying power.

Then there's the deal with Ocado.

Rowe's commissioned the deal to help the Food business find another gear. Its roll-out had, until recently been a shining light, but the division has bumped up against the sides of the tank, and further stumbled as input costs rise and online retailing disrupts the supermarket sector.

The partnership has got several advantages. Ocado is growing rapidly, and there should be numerous cross-selling opportunities between the two client bases. Then there's the fact that running it as a JV means it's more of a plug and play option, so execution risk is reduced.

Still, we can't help but feel the challenges are significant. M&S' heritage is a key strength, but by the same token the well-established identity means successfully transforming both the in-house culture and how the nation sees it will be difficult. There's also significant costs attached to the strategy; M&S has written off over £950m in exceptional costs in just the last two years.

M&S is paying up to £750m for a 50% stake in the Ocado JV. That's a hefty price for an operation that would have generated a total of £50m of cash profits last year, while funding the deal with a rights issue dilutes existing shareholders.

Together with the declining profits, the costs of transformation brought a dividend cut. M&S still offers a prospective yield of a shade over 5%, but with management tying its growth prospects to earnings, the strategy needs to start delivering if the payout is to grow.

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Full year results

Revenues in Food declined 0.6% to £5.9bn, with like-for-like (LFL) sales down 2.3%. However, ignoring the unfavourable timing of Easter, this was a 1.5% decline. Gross margin declined slightly, reflecting increased investment in lower prices and the impact of cost inflation.

In Clothing & Home, revenue of £3.5bn reflects a decline of 3.6%, with LFL sales falling 1.6%, driven by shop closures. However, gross margin improved 0.2%, as fewer items went into clearance sales. Online sales in the UK improved 9.8%.

Food and Clothing & Home saw combined operating profits fall 11.5% to £474m.

The International business saw sales fall 13.4% to £936.6m, due to M&S leaving loss making markets and the sale of its Hong Kong business. Without that sale, international revenues rose 1.1%. Operating profit decreased 6.1% to £127m.

The efficiency programme meant the group delivered savings of around £100m. 26 full-line stores were closed in the year, with 48 new stores opened.

The group expects store closures to negatively impact sales again next year, although this will be offset by a 1% fall in operating costs.

Reduced expenditure, plus lower interest payments resulted in free cash flow of £584.1m (2018: £417.5m). Net debt was reduced 15.3% to £1.6bn.

The group's announced a 1 for 5 rights issue, which aims to raise around £601.3m to fund the tie up with Ocado. New shares will be issued at 185p, a discount of approximately 31.8%.

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