M&S falls into first loss as lockdown stifles clothing sales

Marks & Spencer (MKS) tumbled into a half-year loss after a miserable period for its clothing and home division. An increase in food sales provided some relief, and the retailer’s joint venture Ocado (OCDO) has started well, ensuring M&S didn’t stoop to the 22.8 per cent revenue decline it built into its pandemic forecasts. The share from the partnership also contributed to M&S’s free cash flow of £77.6m, an overall increase of 43 per cent, compared with last year’s first half.

M&S’s food business achieved a 19 per cent boost to operating profits to £109.7m, despite low sales growth of just 2.7 per cent. The division experienced pressures on city centre footfall and the travel sector, where the retailer sells food via rail, air and roadside locations. Sites including the high street and shopping centres also came under pressure, with outlets negatively affected by the pandemic, accounting for almost 40 per cent of last year’s food sales. 

The retailer’s smaller Simply Food outlets and shops in retail parks fared better, exhibiting 19 per cent and 13 per cent growth respectively in the second quarter compared with last year. Operating cost savings across the division managed to offset £67.9m in Covid-related costs over the period. 

M&S’s grocery highlight for period was arguably, however, the successful start to its 50:50 venture with Ocado, which began in September. Earlier this week, Ocado lifted its full-year cash profits guidance above £60m, having previously forecast profits of at least £40m. It also announced the acquisition of two US robotics companies for a combined $287m (£222m).

M&S’s share of Ocado’s net retail profits over its first half came to £38.8m, aided by Ocado retail revenue growth of 47.9 per cent. Of this contribution, however, £28.5m was linked to insurance receipts from a fire at Ocado’s Andover facility in 2019. Online food shopping has become an essential operation during the pandemic (Ocado briefly took Tesco’s crown as the UK’s biggest grocer by market cap over the period). Plans are in place to expand Ocado’s retail capacity with an additional 40 per cent expected by autumn next year.

But the group’s clothing and home division remains an anchor on M&S. Operating losses of £107.5m nearly wiped out profits achieved in the food arm. High streets and city centres were even more unpopular locations for M&S clothing sales than they were for food. But, unlike food, there was also a second-quarter decline in retail park sales, which fell by a quarter compared with the same period in 2019. 

Stock clearance became a priority, with heavy discounting aimed at consumers as an effort to raise money for the NHS also helping to reduce inventories (while £8m was raised for the health service). The division subsequently entered its second half with lower stock levels of £100m, and M&S was able to hibernate less spring and summer inventory than previously planned. 

The easing of restrictions helped clothing and home sales recover from being nearly two-thirds down against last year in the first quarter to a deficit of just over a fifth in the second. But a shift in product mix from formal clothing towards casual garments will likely continue to put pressure on margins, as changes to working patterns reduce the need for higher-margin smart items.

Food and clothing and home sales remain on trend this half, having respectively risen 3 per cent and dropped by more than a fifth over the first four weeks of the period. Retail footfall patterns are a cause for concern, however, with footfall dropping by 32 per cent in October in the UK according to Springboard, compared with a 28 per cent decline in the previous month. 

Shareholders will continue to wait for a payout, having been denied a final dividend for the 2020 period. There will be no dividend this year. 

Peel Hunt analysts forecast full-year 2021 adjusted pre-tax profits and earnings per share of £109.1m and 4.4p, respectively, rising to £239m and 9.6p in 2022.

Given the current circumstances, we feel it makes little sense to value the shares on this year’s lowly earnings estimates. But even on 2022 forecasts, the shares are trading at a premium to last year, with a forward multiple of 10. M&S is in the midst of a new turnaround strategy and has much work to do in salvaging its clothing arm, a task that will be made harder by changes to clothing habits. Sell.

Last IC View: Sell, 110p, 18 Aug 2020