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Marks & Spencer - severe trading disruption over next 9-12 months

Sophie Lund-Yates, Equity Analyst | 20 March 2020 | A A A
Marks & Spencer - severe trading disruption over next 9-12 months

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Marks & Spencer Group plc Ordinary 25p

Sell: 99.06 | Buy: 99.40 | Change -2.94 (-2.92%)
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M&S has said the COVID-19 outbreak will have a severe impact on the Clothing & Home and international businesses over the next 9-12 months.

Trading in the food business has been strong. Overall the group said it's unable to provide "meaningful" guidance on future earnings and full year pre-tax profit could be at or below the bottom end of the guidance range of £440-£460m.

The board does not anticipate paying a final dividend this year.

The shares fell 4.7% following the announcement.

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Our view

Extreme changes are underway in the UK consumer market. COVID-19 has already caused swathes of global retail closures and the impact on footfall is likely to get worse before it gets better.

That's expected to have a severe impact on the Clothing & Home business. Not only is the top line going to be under strain, but margins are going to be hurt. If less stock is shifted and the group's left with piles of inventory it will need to slash prices in order to sell it at a later date.

This could be a particularly painful development because the Clothing & Home business has been struggling for a while, and having a knock on effect for the whole group. Stifling competition in the sector combined with burdensome costs of maintaining a store estate are a chain round the group's ankles and hurt profits.

News of a 12 month holiday from paying business rates is very welcome, but this temporary government handout isn't a long term solution to the wider challenges.

In the group's defence it's trying to fix itself up, and is in the midst of its latest turnaround. The problem is the emergency pause to spending because of coronavirus will slow progress here.

As things progress it will be important to keep an eye on the group's debt position too. To stay in line with terms set by its lenders, underlying cash profits need to be kept at least 2.6 times higher than interest payments and depreciation. If there's a worse-than-expected impact on group cash flow, M&S will find it harder to make its interest payments. We'll get a better idea of where debt levels are in full year results in May.

There are some brighter spots from the food business.

The division had actually been beating the wider market, and the decision to lower prices and simplify promotions is paying off. And as the pandemic progresses and more of us stay at home to eat sales should continue to benefit from the group's stellar home-dining options.

Then there's Joint Venture (JV) with Ocado, with M&S food products available on Ocado's website later this year. That could provide another sales boost, especially as millions of us a likely to rely more heavily on delivery options given the current situation. Given the deal had a price tag of £750m, and was funded by a dilutive rights issue, there's certainly pressure for the deal to pay off.

It's very much a mixed bag at M&S at the moment. There are some very real challenges ahead in the Clothing business, and we don't yet know what the longer-term damage will be from the disruption to trading.

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COVID-19 trading update

In Clothing & Home margins are expected to be significantly impacted. That reflects the anticipated large amounts of unsold stock and the subsequent discounting expected to clear these items. M&S think its position as a go-to shop for staples, rather than seasonal fashion could help mitigate this a little as it will be able to bring forward some stock.

Normal trading is not assumed to resume by the autumn, and the group is preparing for the possibility of some temporary store closures.

Food trading has been stronger, and this division is expected to trade profitably throughout the disruption.

The division isn't experiencing a sales uplift on the same scale as other supermarkets because of its bias towards fresh food. However the shift as more people eat at home is expected to benefit sales in the months ahead.

Employees are being redeployed to the food division from Clothing & Home.

The International business will see significant reductions in sales, reflecting virus outbreaks, closures and lockdowns in some markets.

To cut costs M&S is lowering capital expenditure to around £80m from a budget of £400m. Non-essential spending is being reduced, including freezing recruitment and lower marketing spend.

The clothing supply pipeline is also being reduced by £100m.

The group has access to £1.1bn of undrawn credit. Together with other facilities including cash it has liquidity of £1.34bn. One of the conditions of the undrawn credit is that debt is kept within a certain range: cash profits must remain at least 2.6 times higher than interest payments and depreciation - an accounting term for the cost of wear and tear. This is measured semi-annually and is being monitored.

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