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M&S - lockdowns and excess stock hurt full year profit

Sophie Lund-Yates, Equity Analyst | 20 May 2020 | A A A
M&S - lockdowns and excess stock hurt full year profit

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Marks & Spencer Group plc Ordinary 1p

Sell: 136.20 | Buy: 136.40 | Change -6.10 (-4.29%)
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Underlying full year pre-tax profit was £403.1m, down 21.2% on last year. That reflects an estimated trading impact from Covid-19 of £51.9m in March. M&S has also written down the value of Clothing & Home inventory and some stores because of the pandemic. Including these charges and extra costs, pre-tax profit was just £67.2m.

The group expects the impact of the crisis on sales and stock flow will last for at least the next twelve months. A number of actions are being taken to reduce spending and preserve cash, with a cash outflow expected in the first half. However, while trading has been weak in the first few weeks of the new financial year, it's been better than expected.

As previously announced no final dividend will be paid, and the board doesn't intend to pay a dividend for FY20/21.

The shares were broadly flat following the announcement.

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Our view

Mountains of unsold stock are being locked away until next year, and the group's been forced to recognise the value of these items isn't what it once was.

This has highlighted an existing problem for M&S; its sourcing and manufacturing isn't as nimble as some of its competitors. Buying stock in bulk at the start of a season means it's less reactionary, and has even fallen foul of costly buying mistakes in the past.

The other disappointing trend is the lack of real uplift in Clothing & Home online sales. While most fashion retailers are seeing demand slump at the moment, the group's hinted digital performance had failed to pick up before the outbreak, despite efforts to improve performance. M&S' digital transformation has been a long time coming, and the current disruption has accelerated the shift to online shopping, changing customer habits forever.

If we're to believe M&S can meaningfully take part in the new digital age, improvement is needed. Shareholders that have seen their dividends disappear will hope at least some of the saved cash will be going towards rapidly improving this side of the business.

Stifling competition in the sector combined with burdensome costs of maintaining a store estate are a chain round the group's ankles and have been sinking profits for a while. For now, the extent of the damage will depend on how quickly demand returns to normal - and the rate at which the latest transformation efforts bear fruit. Progress is going to be slower here thanks to the slashing of non-essential spending and an unavoidable focus on survival rather than improvement.

It doesn't help that the food business, which has been something of a redeeming feature, is coming under pressure too. M&S' food offering is very different to the bigger supermarkets - frequent but small, city-centre shopping trips are an important part of the story. A long-term shift to home working would undermine the model.

There are brighter spots though, Ocado's UK retail business (in which M&S now holds a 50% stake) is currently performing well, and the launch of M&S own products on Ocado is running to schedule. As millions of us are likely to lean more heavily on delivery options from here, we think this puts M&S in a good position.

We don't have immediate concerns over M&S' liquidity. But with margins already thinning, if performance were to slip more than expected that opinion could change as servicing debt payments becomes more difficult.

Overall M&S was facing challenges before coronavirus and these have simply been exacerbated. Within the difficulties there are opportunities, but the next chapter really needs to be about execution.

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Full year results

Group revenue declined 1.9% to £10.2bn, largely thanks to a weaker Clothing & Home performance.

Revenues in Food rose 2.1% to £6.0bn, including a 1.9% rise in like-for-like (LFL) sales. Food sales have been "resilient" since the coronavirus outbreak, but M&S didn't experience the same stockpiling behaviours as the supermarkets. Operating profit was 11.2% higher at £236.7 thanks to lower operating costs, which offset lower gross margins as the group continued to lower its prices.

The acquisition of 50% of Ocado Retail completed on 5 August, with M&S' share of profit totalling £2.6m in the 7 months to 1 March.

In Clothing & Home revenue fell 8.3% to £3.2bn, with March lockdowns having a negative impact of £78.1m. LFLs fell 6.2%. Online performance has not picked up as quickly as hoped and is now under new management. Operating profit fell 37% to £223.9m as operating margins fell to 7% from 10.1%. That reflects a depressed gross margin as costs increased and discounting was higher than expected.

The group has a lot of unsold stock for the current season, and is storing much of it for sale next year. This action has incurred write-downs in the value of that stock, as well as extra costs for storage and distribution.

In the International business revenue fell 2.5% to £944.6, excluding the impact of exchange rates. Operating profit fell 15.2% to £110.7m.

M&S bank income was down £10.2m to £16.8m. That reflects an increase in provisions for bad debt, because there's a higher risk of customers defaulting on their loans.

M&S plans to reduce costs by around £500m, including stopping all non-essential spending. Marketing and logistic costs will be lower in Clothing & Home, and technology spending is also being cut. Other plans to preserve cash flow are also expected to save £500m, and as such capital expenditure has been reduced to £140m for the year.

Despite lower profits, changes to rental terms meant net debt was £50.2m lower than last year at £4bn.

M&S will experience a cash outflow in the first half of the year, and therefore expects to draw £300m - £350m of its available credit this year. The group has access to a £1.1bn revolving credit facility, and the financial terms set by its lenders (known as covenants) have been relaxed. M&S also confirmed it's eligible to access the UK Government's Covid Corporate Financing Facility (CCFF), and therefore has access to a further £300m.

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