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Marks and Spencer Plc

Marks and Spencer Group Plc Good progress in restoring the basics

Marks and Spencer Group Plc (LON:MKS), today announced Full Year Results For 52 weeks ended 30 March 2019.

52 weeks ended30 Mar 1931 Mar 18Change %
Group revenue£10,377.3m£10,698.2m-3.0
Profit before tax & adjusting items1£523.2m£580.9m-9.9
Free cash flow before adjusting items2£729.4m£582.4m25.2
Adjusting items1,2£(438.6)m£(514.1)m14.7
Profit before tax£84.6m£66.8m26.6
Profit after tax£37.3m£29.1m28.2
Basic earnings per share before adjusting items125.4p27.8p-8.6
Basic earnings per share2.1p1.6p31.3
Net debt£1.55bn£1.83bn-15.3
Ordinary dividend per share13.9p18.7p-25.7
     

1Adjusted results are consistent with how business performance is measured internally. 2Refer to adjusting items table below for further details.  See glossary for definitions and reconciliations to statutory measures.

Steve Rowe, Marks & Spencer CEO said:

“We are deep into the first phase of our transformation programme and continue to make good progress restoring the basics and fixing many of the legacy issues we face. As I have said, at this stage we are judging ourselves as much by the pace of change as by the trading outcomes and change will accelerate in the year ahead.

“Whilst there are green shoots, we have not been consistent in our delivery in a number of areas of the business. M&S is changing faster than at any time in my career – substantial changes across the business to our processes, ranges and operations and this has constrained this year’s performance, particularly in Clothing & Home. However, we remain on track with our transformation and are now well on the road to making M&S special again.”

Transformation – good progress

· Accountable businesses established with substantial changes in leadership

· Food business on track with Q4 like-for-like revenue of 0.4% and volume growth of c.1.8% adjusted for Easter timing. Transition to trusted value and wider appeal underway

· Underlying progress in Clothing in changing ‘shape of buy’, sizing, customer focus and style plus 14% reduction in stock into sale

· Improving the basics of dotcom, download speeds, fulfilment; 22% of UK Clothing & Home revenue now online compared with 19% last year

· UK store portfolio reshaping progressing with 26 full-line stores closed and 48 new store openings in the year. Programme expanded and larger store redevelopment planning initiated

· Good progress on cost savings delivering c.£100m, in addition to the operating costs of stores which have closed

· Transformational Joint Venture (“JV”) with Ocado announced; a strategically compelling route to unlock profitable growth for M&S Food

· Proactive steps taken to strengthen and secure the balance sheet for future growth; final dividend for 2018/19 of 7.1 pence

· Announced terms of a 1 for 5 Rights Issue at 185 pence per New Ordinary Share to raise gross proceeds of approximately £601.3m

Financial performance held back by operating challenges

· Profit before tax & adjusting items down 9.9% driven by headwinds on sales, partly offset by the operating costs transformation programme

· Adjusting items of £438.6m, including £222.1m reflecting the costs of acceleration and extension of our UK store closure programme

· UK Food revenue down 0.6%, with like-for-like revenue down 2.3% (1.5% adjusted for Easter) with improving underlying trend in Q4. Gross margin down 15bps as investment in trusted value was largely offset by reduced promotional spend

· UK Clothing & Home revenue down 3.6%, impacted by store closures, with like-for-like revenue down 1.6%. Gross margin up 20bps driven by 14% lower stock into sale. Encouraging signs of progress in Q3, particularly online, constrained by weak availability in Q4 as we sold out of a number of fast selling lines

· Net debt reduced to £1.5bn, as a result of working capital inflow and tight capital expenditure

Restoring the Basics

The objective of our transformation programme is to create a profitable, growing family of businesses under the M&S brand within three to five years, bound together not only by a common consumer brand but also by shared sites, employment values, technology and customer data. The first phase of the transformation programme is about restoring the basics; getting the organisation and infrastructure of the business fit for the future.

Protecting the magic and modernising the rest in Food

The Food business is showing good signs of progress in arresting the decline in like-for-like revenue. UK Food revenue declined 0.6%, with like-for-like revenue down 2.3% reflecting the adverse impact of Easter timing in both Q1 and Q4. Adjusted for Easter timing, FY 18/19 like-for-like revenue declined 1.5% with an improving trend in the second half of the year, and like-for-like revenue and volume growth in Q4.

Our Food brand remains very strong and our strategy is to protect the magic which is based on our unique quality, freshness, and innovation credentials whilst reshaping our store estate, infrastructure, operating systems, cost management and supply relationships. The Ocado JV is a natural partner for the brand and combined with our Food transformation plan, opens up the possibility of substantially increasing our grocery market share in the medium term.

Phase 1 fixing the basics of this plan is about addressing the basic operating weaknesses in the business and broadening our appeal to attract a wider range of customers and be relevant to more shopping occasions.

Good progress has been made in restoring trust in our value at relatively little cost to margin. We have nearly halved our dependence on the short-term promotions and complex multi-buy offers, reducing promotional participation by over 10 percentage points as a percentage of sales by the year end, without significant loss of customers. This enabled us to invest in everyday prices including reductions in over 400 lines, narrowing our price differential to the lowest it has been for some years.

We have strengthened the communication of value in stores and we began to see encouraging transaction and volume trends in Q4. In the current year a series of workstreams designed to simplify supply relationships, reduce costs and increase the pace of innovation will support our work to build trusted value.

Our food waste levels remain amongst the highest in the industry and availability has not significantly improved. However, process changes in trial stores known as Project Fuse are illustrating the very significant financial opportunity in these areas.

Similarly, an improved working relationship with GIST, our logistics partner, has demonstrated the substantial opportunity in modernising and better integrating the supply chain.

Reshaping the ranges and customer profile in Clothing & Home

UK Clothing & Home revenue declined 3.6%, partly due to our store closure programme, with like-for-like revenue down 1.6%. UK Clothing & Home online revenue grew 9.8%, with clothing growth ahead of the online market. Encouraging progress in Q3 was constrained by weak availability in Q4 as we sold out of fast selling lines and experienced supply issues.

Our range remained too wide in FY 18/19 with the volume of options in our range splintering our buying scale and making our shops challenging to navigate. Our size ratios have been historically misaligned with the profile of the contemporary family age customer we aim to appeal to. However, where we have made progress in pruning options and introducing slimmer fits and more mid sizes, the customer response has been very strong. For instance, our new denim launch produced an initial 20% sales uplift and our sales of £15 women’s jeggings were up 30% over the campaign period.

Creating a new range architecture in a business with weak processes, a slow supply chain and where buyers are building their confidence has proven challenging, and our sales both in store and online have been frustrated by poor availability in Q4. Although we made good progress reducing overall stock levels, with stock cover down almost three weeks and stock into sale down 14% across the year, many popular lines have sold out prematurely because of the failure to increase the depth of buy and the slowness of the stock flow.

Despite these teething problems the customer response to the initial changes has been very encouraging. In the year ahead, we expect to deliver a more marked reduction in options and range duplication, with a substantial increase in the number of ‘£1m+’ lines for Autumn, a significant improvement in size ratios, further focus on style and fashion and additional investment in value. This will be reinforced by the update of the sub brand strategy, including the re-launch of the Per Una range where the initial customer reaction to early changes we have made has been positive.

With the new range architecture, we will aim to shift to a ‘first price, right price’ trading philosophy, and further reduce the percentage of Clothing & Home sold at discount which remains too high.

Our new range architecture and presentation will be combined with a rationalised, more contemporary in store environment. Around one third of our full-line stores were opened before WWII and three quarters are older than 25 years. Progress on renewing the stores has been limited to date although we have moved a lot of internal walls and sight barriers. A renewal brand format and a modernisation will be piloted in the year ahead.

We have reduced the complexity of our logistics network, closing four distribution centres and warehouses and opening a national distribution centre in Welham Green, which is now ramping up its boxed storage capacity. Along with foods we are rolling out the first phase of our Fuse programme, deploying new tools which will help us remove excess stock trapped in stores where it does not sell, and holding it centrally, improving availability and making our stores easier to shop. We are still at the early stages of modernising our supply chain network, technology and process and this remains a priority.

Transforming our leadership and accountability

Over the past two years we have built a substantially new leadership team, bringing fresh perspective, energy and challenge to a business held back by deeply entrenched cultural norms. Our ambition is to intensify cultural and behavioural change throughout M&S, driving the business to act ‘bigger, bolder, faster’. We are creating clear and accountable businesses supported by common values, shared infrastructure and customer data and have continued the streamlining of corporate functions. The Clothing & Home and Food businesses now have end-to-end functional accountability, enabling more efficient and effective decision making.

Critically we are taking steps to bring back the voice of the stores. Over the years a business that was famously product and store led has developed a ‘Head Office knows best’ mentality, remote from the customer. In our new organisation we are ensuring that the role of the store is central to all our activity, whether that be active engagement in range decisions for the first time or store managers leading the trading feedback calls which are attended by all commercial executives. Store managers will now have visibility of their own P&Ls, and Food managers are given the granular information to act on their own waste. M&S has an extraordinary workforce of loyal colleagues and our aim is to be the most involving workplace in large scale UK retail.

Becoming a digital first retailer across M&S

In our digital operations, we began to address the basics of our website which has helped to deliver UK Clothing & Home online growth of 9.8% in FY 18/19, improving our online clothing market share by 0.3 percentage points. During Q3, when we had strong seasonal demand, growth was well into double digits.

Improvements in site speed, a redesigned homepage, enhanced product imagery, a simpler check-out and an improved delivery proposition have collectively contributed to over nine percent improvement in the conversion of website traffic to customer purchases. We are top quartile amongst our peers on page loadspeed. Navigation and personalisation on-site, as well as product marketing remain a significant opportunity.

Castle Donington had its best peak performance since it opened with significant improvements in most key metrics including a later delivery cut off, following targeted investment to remedy problems with its reliability, efficiency and capacity. We are investing c.£9m in further process improvements to meet our growth plans for this year. However, we expect that the need for an additional fulfilment centre has been successfully deferred for another two to three years.

M&S in store technology and systems have been historically underinvested and require improvement. Already we have started to address this problem, giving all store managers tablet computers to release office bound time for the shop floor. The successful Honeywell hand held terminal programme has been extended. In the year ahead, we will roll out new applications and accelerate our self-checkout programme to reduce constant queuing issues. Our in store WiFi will be upgraded with the objective of delivering a universal ‘high speed anywhere’ capability for our customers and store colleagues.

M&S has the potential to have one of the strongest and most valuable customer data ‘lakes’ in the UK with the combination of Sparks, Online, the M&S credit card and Ocado. However, our customer data bases are currently disconnected and ineffective. Our Sparks loyalty programme needs substantial improvement and in the next year it will be repositioned, revamped and relaunched.

We have made good progress restoring the basics of our technology organisation, transitioning to a partnership with TCS, migrating our online platform to the cloud and rolling out new warehouse management software to enable the decommissioning of obsolete systems and the old mainframe base, which will deliver annualised savings of over £30m.

Our long-term partnerships with Microsoft, Decoded, Founders Factory and True Capital will also help give M&S the opportunity to access the best of digital innovation and entrepreneurial ideas and to become a data-driven and digitally enabled workforce.

Creating a high-quality store portfolio fit for the future

Our store estate is older than that of our competitors with a number of legacy issues. We are making good progress and have closed 35 full-line stores as part of our programme as at 30 March 2019, with sales transfer rates to nearby stores remaining above 20%. We have updated our plan for the future shape of our total store estate. Reshaping the store portfolio means tackling the legacy issues, but also opening new full-line stores as well as Food stores where we can exploit current weak retail demand to secure excellent sites for relocations. As part of our Food strategy we are concentrating on higher volume stores with good access and car parking to enable our customers to shop more of our range. Therefore, some of the low volume, higher cost Simply Food stores, mostly on short-leases will also be progressively relocated or rationalised.

Although we anticipate further net reductions in overall retail space, and we currently expect to close a further c.85 full-line stores and c.25 Simply Food stores in addition to the 35 full-line stores closed at FY18/19, our strategy is as much about right sizing, relocating and new openings as it is about closures. As such we anticipate our owned store base is likely to remain broadly level.

As indicated at the half year we believe there is significant opportunity for rental cost reductions as we are reviewing our existing leaseholds.

We have also begun a programme of development feasibility to unlock value from the large old town centre stores with surplus space. We have appointed a new Property Development Director and expect to initiate a number of redevelopments in the year ahead.

Cost savings of at least £350m by 2020/21

Last year we set out firm targets for cost savings as part of the first phase of transformation. We have made good progress in the year, delivering savings of c.£100m, in addition to the operating costs of stores which have closed and are on the way to creating a leaner, more efficient cost base for the business.

Savings in 2018/19 derived from areas including the retail management restructure, the IT transformation plan, property costs, depreciation and central costs which enabled the business to offset inflation, new space and channel shift with the result that FY UK operating costs declined by 1.2%.

As we change the culture of the business we are clear that challenging costs will become a core part of our philosophy. In 2019/20 we anticipate ongoing savings from the annualisation of current year initiatives and additional benefits in areas including a new contract for store maintenance and in central costs, which should result in a further decline in total UK operating costs.

Rebuilding profitable growth in International

International revenue decreased by 13.4% at constant currency driven by the closure of stores in loss making exit markets, and the sale of our business in Hong Kong to a franchise partner in December 2017. Excluding Hong Kong and exit markets, revenue grew by 1.1%.

The International business was already fully embarked on rationalisation and repositioning prior to the transformation programme and further good progress has been made. Our objective is to create a much more competitive localised incarnation of M&S in those selected markets where we can attain a sustainable market share. During the year, we have implemented the ‘market right pricing’ programme across markets in Clothing & Home. The programme’s cumulative performance since implementation has been encouraging with sales up 8% and volumes up 20%, following a net 10% reduction in selling prices. This performance is helping to build confidence with our partners to reinvest into the business. In the year we opened 37 stores and modernised a further 56.

As we aim to build a scalable business internationally, we continue to localise our ranges for the market. This included a substantial increase to around 15% of locally designed clothing ranges, including an increase in our growing Indian joint venture which now has 77 stores. In addition, we launched our first ever Halal meat range in the UAE and also launched six country specific websites. We also re-platformed the website for our business in the Republic of Ireland.

Joint Venture with Ocado

In February 2019, we announced the creation of a new 50/50 JV with Ocado Group Plc (“Ocado”), the UK’s leading pure play digital grocer, that will transform online grocery shopping for UK consumers. Under the JV, M&S is acquiring a 50% share of Ocado’s UK retail business, which will be supported by Ocado Smart Platform technology, for an initial consideration of £562.5m and deferred consideration of up to £187.5m, plus interest. The Ocado JV is expected to be recognised by M&S as an associate applying the equity method of accounting, reflecting the significant influence that M&S will have over the entity.

The JV combines the strength of M&S’s brand and its leading food quality and innovation with Ocado’s unique and proprietary technology to create an unrivalled online offer for customers. In bringing the best together, the JV will benefit existing and new customers, colleagues and suppliers.

The JV will trade as Ocado.com but benefit from access to M&S’s brand, products and customer database from September 2020 at the latest, following the termination of the current Waitrose sourcing agreement and migration of JV sourcing to M&S.

We anticipate synergies for M&S of at least £70m by the third full financial year following completion through increased buying scale, harmonised buying terms on branded products and improved efficiencies on new product development. We expect some churn in customers as the JV transitions from the previous sourcing arrangements, however following the ‘frictional’ transition we plan to accelerate growth in the JV. There is a significant opportunity to reduce customer acquisition costs in the JV by marketing directly to our customer data base and the c.12 million M&S food customers who account already for around one third of online grocery spend, albeit mostly with our competitors.

Balance sheet and transaction financing

The Board believes that, given the high operating risk the business faces, it is important to maintain a strong balance sheet and cashflow, to provide security and underpin the changes we need to make. In the next four years, in addition to the investment in our proposed JV, we have substantial debt repayments due on our bond financing and a significant pension obligation to fund. Further, in uncertain times our strong preference is to limit dependence on bank debt financing.

Therefore, having considered carefully other options, we believe it is appropriate to finance the JV by means of a Rights Issue and to reduce the Group’s annual dividend payment to a sustainable level, which we aim to grow in line with earnings over time.

Details of the Rights Issue

On 27 February 2019 we announced the creation of a new 50/50 JV with Ocado. It was announced that the transaction would be primarily equity financed by a rights issue.

Today we announce the terms of the fully underwritten rights issue which is intended to raise gross proceeds of approximately £601.3 million.

The Rights Issue will result in the issue of 325.0 million new ordinary shares representing approximately 20.0% of the existing issued share capital of the Company and 16.7% of the enlarged issued share capital following completion of the Rights Issue. The Rights Issue will be on the following basis:

1 for 5 Rights Issue at 185 pence per New Ordinary Share

The rights issue price of 185 pence per New Ordinary Share represents a discount of approximately 31.8 per cent. to the closing middle-market price of 271.2 pence per existing ordinary share, or a discount of approximately 30.0 per cent. to the closing middle-market price of 264.1 pence per existing ordinary share when adjusted to reflect the ordinary shares becoming ex-dividend during the Rights Issue offer period, in each case on 21 May 2019 (being the latest business day before the announcement of the terms of the Rights Issue). Additionally, it represents a discount of approximately 28.0 per cent. to the theoretical ex-rights price of 256.8 pence per New Ordinary Share, or a discount of approximately 26.3 per cent. to the theoretical ex-rights price of 250.9 pence per existing ordinary share when adjusted to reflect the ordinary shares becoming ex-dividend during the Rights Issue offer period, both on 21 May 2019 (being the latest business day before the announcement of the terms of the Rights Issue).

It is anticipated that the Rights Issue will formally launch on or around 24 May 2019, subject to and following the approval of the Prospectus by the FCA. At this time further details of the Rights Issue will be provided to shareholders.

Full year guidance 2019/20

We remain in the difficult early stages of our transformation programme and while we expect some improvement in trading in each of our major businesses in the year ahead, progress is likely to be second half weighted. Trading in the first seven weeks of the financial year is in line with Board expectations, although the pattern of trade remains volatile in the context of weather and events. All guidance is shown before the effects of IFRS 16. For further detail on IFRS 16 please see Note 1 to the financial statements.

· In Food, we expect net store closures to reduce sales by c.1% as the accelerated store closure programme is not fully offset by new Simply Food and full-line stores. We anticipate gross margin to be -25bps to +25bps, as we balance further investment in trusted value with our cost reduction programme

· In Clothing & Home, we expect net store closures to reduce sales by c.3%. We anticipate gross margin to be -25bps to +25bps, with further investment in trusted value

· We expect UK operating costs to decrease by up to 1%, largely as a result of continued cost efficiencies, store closures and lower depreciation

· Capital expenditure is expected to increase to between £350m and £400m, largely as a result of an increase in investment in store environment, new store trials and C&H logistics capacity

· We expect an adjusted effective tax rate of c.23%

 Full year guidance
UK Food 
–      Space contribution (%)c.-1
–      Gross margin change (bps)-25bps to +25bps
Clothing & Home 
–      Space contribution (%)c.-3
–      Gross margin change (bps)-25bps to +25bps
UK operating costs (%)c.0 to -1
Adjusted effective tax rate (%)c.23
Capital expenditure (£m)350 to 400

Group revenue: constant currency

Q4 group revenue declined by 1.6% at constant currency reflecting the increasing pace of closures in our UK store estate and the adverse impact of Easter timing on like-for-like revenue of an estimated c.1.9% in Food and c.0.4% in Clothing & Home. International revenue grew 1.8% with exit market store closures and the sale of our retail operations in Hong Kong now largely annualised. Revenue at M&S.com reflects the planned reduction in promotional activity in our Food business, with solid underlying growth in clothing orders.

% changeFYQ1Q2Q3Q4
Food-0.6-0.1-0.2-1.2-0.8
–      Like-for-like-2.3-3.1-2.7-2.1-1.5
Clothing & Home-3.6-1.6-3.7-4.8-3.9
–      Like-for-like-1.6-0.6-1.6-2.4-1.3
Total UK sales-1.8-0.7-1.6-2.7-1.9
–      Like-for-like-2.0-2.2-2.3-2.2-1.4
International-13.4-21.1-15.8-15.11.8
Total Group-2.9-2.9-3.1-3.9-1.6
Total M&S.com (Memo only)5.06.35.07.20.2
UK Clothing & Home online (Memo only)9.89.98.514.14.9

See glossary for definitions.  Prior year revenue has been restated for the reclassification of cards & gift wrap from Clothing & Home to Food.

We will report our first half results on 6 November 2019.

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