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Marks & Spencer - performance improves, but inflation looms

Marks & Spencer - performance improves, but inflation looms

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Marks & Spencer Group plc Ordinary 1p

Sell: 144.55 | Buy: 144.80 | Change 0.00 (0.00%)
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Full year underlying sales rose 6.9% compared to pre-covid levels to £10.9bn. This reflected strong growth in UK Food as well as growth in UK Clothing & Home.

Operating profit rose by 20% to £709.0m compared to 2020, as double-digit increases in UK Food and UK Clothing & Home offset weakness in International and MS Bank and Services.

M&S expects that inflationary headwinds will negatively impact volumes and drive sales growth lower through the end of the year. So far this year trading has been ahead of comparable periods, but this is expected to worsen as the year progresses. Still, the group plans to increase investment, spending around £400m this year on things like digitization and supply chain efficiency.

Shares rose 3.4% following the announcement.

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Our view

Marks & Spencer did well at the full year mark. The biggest development came in the form of a weaker outlook. The cost-of-living squeeze is expected to affect performance. This is largely outside of M&S' control - and while it shouldn't be ignored, we think it's important to look at the bigger picture. That shows how much of a corner the retail giant has turned.

Most notably, the improving trends in Clothing & Home sales is a serious benefit. M&S has been forced to grasp the nettle and shrink its store estate after years of lacklustre sales coupled with burdensome property costs dragged profits down. Tens of stores are closing and countless roles have been made redundant across numerous levels. The pain of the pandemic sped up this restructuring process, and the results are very much being felt.

Crucially, the pivot is also providing a very welcome shot in the arm to online sales. That's an area M&S has sorely struggled with in the past. Expanding in-store fulfilment capacity helped the group make the most of this asset during the all-important Christmas period, a move that should continue to pay dividends moving forward.

We can't knock progress, but we'd be remiss not to mention how tough the world of clothing retailers is. M&S isn't quite a modern-day heavyweight online, and the longer-term outlook for physical retail is very hard to map. With this in mind, and the paired-back nature of the refreshed clothing business, means grocery now takes top billing. And performance to date has been impressive.

Much of the recent sales progress can be put down to the joint venture with Ocado. With a genuinely differentiated offer, we think the M&S food business has potential. That's compounded by the work M&S has put into improving customer perception of the value for money it can offer.

M&S food is also more protected from the rising inflation we're seeing at the moment. At a more premium end of the market, M&S' core customers aren't as sensitive to price. But that isn't the same as being immune. Sustained high inflation or a recession will take some wind out of the group's sails. Increased investment in online capacity is also going to hold things back from a profit perspective in the short-to-medium term.

Under the hood M&S is slicker too. It's improved its payment terms with suppliers, and good cost control means free cash flow is enjoying a boost. Net debt levels are in a much more comfortable position too.

Ultimately, we can't knock management's impressive about-turn in the face of the pandemic. But there are plenty of inflation-related uncertainties ahead, some volatility in the near-term is to be expected.

Marks and Spencer key facts

  • Price/Earnings ratio: 7.3
  • 10-Year Average Price/Earnings: 11.7
  • Prospective dividend yield (next 12 months): 5.6%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Full Year Results (all figures underlying and compared to 2020)

Sales in UK Clothing & Home rose 3.8% to £3.3bn, driven by online sales and strong adoption of the group's app. However, adjusting for the impact of Covid at the end of the comparative year, sales growth is estimated to be closer to 1.4%. Discounting levels have come down from 35% to 18%, reflecting progress on the group's transformation strategy. This helped operating profit rise from £223.9m to £330.7m, despite the return to more normal return rates.

UK Food saw sales rise 10.1% to £6.6bn as improved performance in core categories partly offset reduced sales among franchise and hospitality businesses. Customer and transaction numbers remained lower, but more people used M&S for their everyday shop which meant per-person spending rose 26%. The impact of digitization helped costs, particularly staffing costs, fall. This meant operating profits rose 17.4% to £277.8m.

Ocado Retail, in which M&S holds a 50% stake, saw revenue fall 4.4% against 2021, reflecting the surge in online shopping during the previous year and a fire at one plant. The normalisation of shopping habits together with worse profitability at newly opened distribution centres brought profitability lower. As a result, M&S's portion of Ocado Retail profit after tax fell from £78.4 to £13.9 year-on-year.

International sales rose 1.7% to £937.2m, ignoring the impact of exchange rates. This was driven by a recovery in Clothing and Home sales above pre-pandemic levels, particularly in the Middle East. Food Sales were lower thanks to EU border issues, making it costlier and more difficult to serve the Republic of Ireland. This contributed to a 33.5% decline in operating profits for the segment.

The Bank and Services arm reported a £3.0m loss, largely due to mis-selling provisions. Excluding these, profit was down £3.8m to £13m due to lower demand for unsecured credit and travel money.

Free cash flow improved from £493.5m to £699.2m thanks to higher profits and improved working capital management. This fed into a £1.25bn reduction in net debt to £2.7bn.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.