Marks and Spencer (MKS) wanted to rip down its flagship Oxford Street store and build a glass palace of commerce in its place. In the eleventh hour, however, housing secretary Michael Gove intervened to preserve the building, with its stately Art Deco edifice and warren-like interior. The pattern of events will be familiar to any long-term M&S shareholder. The retailer has tantalised investors with the promise of reinvention for the past two decades, only to remain trapped in an ageing, siloed business model.
Something has changed over the last year, however. In May, M&S’s full-year profits came in £50mn higher than analysts had expected and, this month, the group upgraded its 2024 profit guidance. Shares are up 70 per cent year-on-year as a result, and M&S is on the cusp of re-entering the FTSE 100.
Trolley half full
M&S is a business of two halves. On one side there’s the food division, with its abundance of fresh produce and sumptuous ad campaigns. On the other side, there’s clothing & homeware (C&H), which is more associated with strip lighting and sensible slacks. While food sales have been on an upward trajectory for many years, C&H revenues were languishing before Covid hit, as the group failed to shift its frumpy image.
The arrival of new managing director in that division, Richard Price, has shaken things up, however. Sales almost sprang back to 2017 levels in the year ended March 2023, and growth has continued into the summer.
The strategy is fairly simple: cut back the clothing range by about a third, order more of certain items, and prioritise everyday products over formalwear.
This isn’t just driving sales, but full-price sales. Promotions accounted for just 20-25 per cent of revenue in financial year 2023, down from 30-35 per cent in 2020. “The product has improved and M&S is giving customers what they want - that has been clear for a while,” said Kate Calvert, head of retail at Investec.
Success depends on more than customer sentiment, however. The new management team, headed by chief executive Stuart Machin, has also strengthened the financial backbone of M&S, driving net debt excluding lease liabilities down from £1.46bn in March 2020 to £356mn in March 2023.
Shore Capital believes that net debt (excluding leases) will fall to £250mn-£300mn by March 2024, and that M&S will achieve a net cash position over the next three years. “That takes the pressure off management and will probably deliver investment grade status to M&S's debt, which will lower its financing costs and give optionality to management,” said Shore Capital director Clive Black.
M&S also intends to restart dividends in November after suspending payments in April 2020.
Trolley half empty
The problem with transformation is that it doesn't come cheap.
As well as trendier clothing lines, M&S has been pumping money into logistics and new shops. This makes a lot of sense: management has admitted that supply chain processes “remain inefficient by industry standards”, in the words of chair Archie Norman, and the C&H division is significantly less profitable than the likes of Next (NXT).
Meanwhile, three-quarters of its full-line stores are over 25 years old and many have been open since before the second world war. It’s not surprising, therefore, that management is planning a portfolio makeover by reducing the number of full-line stores from 250 to 180 over the next five years, shifting shops from high streets to retail parks, and opening more food halls.
Indeed, in some ways this is part of M&S’s bull case. Management is no longer just tinkering with interiors and marketing, but tackling the root problems.
Modernisation, however, is a drag on profits in the meantime. Adjusting items - which include the shake-up of the store estate and supply chain - amounted to £112mn in 2023 and £137mn the previous year. “The never-ending restructure rolls on it seems and that is the point here - legacy businesses are always playing catch-up,” Panmure Gordon said in a note in May.
Profit adjustments are getting less extreme, and capital expenditure is lower than a decade ago. (Analysts at Barclays said M&S “deployed new capital too freely in the past” through over-expansion and “ineffective infrastructure spend”.) However, the latter is expected to remain at the £400mn-£450mn mark, which will weigh on cash flow.
More importantly, though, is that investment is not yet translating into margin gains. This is particularly the case for the online C&H business, which analysts consider an important source of growth and which reported a steep decline in profitability in 2023.
This whistle-stop tour doesn’t begin to address M&S’s partnership with Ocado or the de-risking of its international business. Ultimately, however, it is enough to make us cautious. While the fresh-faced management team is making good progress, the aged retailer still has a long way to go and we want to see more evidence of a spark turning into a flame. For now - hold.
