# Marks & Spencer Group Ocado Retail positioned strongly for growth

- Link: https://www.directorstalkinterviews.com/marks-spencer-group-ocado-retail-positioned-strongly-for-growth/412823596
- Published: 2020-05-20T08:26:08+01:00
- Author: Amilia Stone

**Marks and Spencer Group Plc** (LON:MKS) has today announced its Full Year Results
For 52 Weeks Ended 28 March 2020.

| 52 weeks ended | 28 Mar 20 | 30 Mar 19Restated^(1) | Change % | 
| Group revenue | £10,181.9m | £10,377.3m | -1.9 | 
| Profit before tax & adjusting items | £403.1m | £511.7m | -21.2 | 
| Adjusting items | £(335.9)m | £(427.5)m | 21.4 | 
| Profit before tax | £67.2m | £84.2m | -20.2 | 
| Profit after tax | £27.4m | £45.3m | -39.5 | 
| Adjusted basic earnings per share | 16.7p | 23.7p | -29.5 | 
| Basic earnings per share | 1.3p | 2.5p | -48.0 | 
| Free cash flow^(2) | £225.0m | £580.8m | -61.3 | 
| Net debt | £4.03bn | £4.08bn | -1.2 | 
| Net debt excluding lease liabilities | £1.46bn | £1.50bn | -2.6 | 
| Dividend per share | 3.9p | 13.3p | -70.7 |

^(1 )_Prior year comparatives restated for the adoption of IFRS 16 ‘Leases’ and 
for the effects of the rights issue completed in June. _

^(2 )_Free cash flow is cash generated from operating activities less capital expenditure,
cash lease payments and interest paid._

_There are a number of non-GAAP measures and alternative profit measures “APM”, 
discussed with this announcement and a glossary and reconciliation to statutory 
measures is provided at the end of this report. __Adjusted results are consistent
with how business performance is measured internally and presented to aid comparability
of performance. Refer to adjusting items table below for further details._

> Steve Rowe, Ma**rks & Spencer CEO said: **“Last year’s results reflect a year 
> of substantial progress and change including the transformative investment in 
> Ocado Retail, outperformance in Food and some green shoots in Clothing in the 
> second half.  However, they now seem like ancient history as the trauma of the
> Covid crisis has galvanised our colleagues to secure the future of the business.
> The way our people have rallied to support our customers and communities has been
> awe-inspiring. From the outset we recognised that we were facing a crisis whose
> effects and aftershocks will endure for the coming year and beyond: Whilst some
> customer habits will return to normal others have changed forever, the trend towards
> digital has been accelerated, and changes to the shape of the high street brought
> forward. Most importantly working habits have been transformed and we have discovered
> we can work in a faster, leaner, more effective way. I am determined to act now
> to capture this and deliver a renewed, more agile business in a world that will
> never be the same again.”

●     Profit before tax & adjusting items £403.1m, including an adverse profit impact
of c.£52m in March which we largely attribute to Covid-19

●     Profit before tax of £67.2m including adjusting items of £335.9m, with £212.8m
for costs and stock write downs for Covid-19

●     Strong Food LFL revenue of 1.9% and operating profit up 11.2%. Volume outperforming
the market

●     Clothing LFL revenue decline of 6.2% and operating profit down 37.0%, adversely
impacted by availability in H1. Reengineering of ranges accelerating during the 
year

●     Acquired 50% of Ocado Retail, a valuable investment in online grocery which
transforms the growth potential of M&S Food. Ocado Retail delivered 40.4% revenue
growth for the 9 weeks to 3 May. Switchover and synergy plans on track

●     Progress against transformation priorities, helping the business to withstand
the crisis

●     Over £1bn of actions, including c.£500m of planned cost reductions and further
actions to manage cash under scenario planning for Covid-19

●     Liquidity secured including removal or substantial relaxation of covenants
on the £1.1bn revolving credit facility (RCF). Eligibility to the UK Government’s
Covid Corporate Financing Facility (CCFF) confirmed and £300m allocated

●     Outperformance against Covid-19 scenario, with cashflow over £150m better 
than scenario after six weeks, largely driven by trading

●     Launched the Never the Same Again programme to draw on learnings from the 
crisis and capitalise on the opportunities to drive the transformation plan in a
changed consumer environment.

**Good progress on transformation in 2019/20**

Prior to the Covid-19 impact, both major businesses were making good progress in
implementing the transformation programme with Food outperforming the market and
despite teething issues in changes to men’s clothing ranges, kids, womens, and lingerie
starting to show sustained, improved performance.

In recent years we have made a number of structural changes to the basic infrastructure
of the business including closing 54 of our legacy shared stores, migrating off 
mainframe infrastructure to cloud based systems and implementing new warehouse management
systems. These changes have been instrumental in helping the business to react effectively
in the early weeks of the crisis.

To illustrate more clearly our new more decentralised model, we are for the first-
time introducing segmental profit reporting in our family of businesses: UK Food,
UK Clothing & Home and International. This demonstrates the strength and balance
of the combined businesses, which has been a major source of resilience in the crisis.

**Outperformance in Food**

The UK Food business outperformed the market and saw strengthening sales performance
as changes to range, value, and customer communication took effect: revenue increased
2.1%, with LFL sales up 1.9%, strengthening throughout the year, including an estimated
0.3% benefit from the effects of Covid-19 in March. Operating profit before adjusting
items increased 11.2%. Value perception has improved resulting in growth in volume
ahead of value at 3.3%.

We set out the strategy for Food 18 months ago, rebuilt the leadership team and 
started the repositioning of the business to broaden its appeal and move to ‘trusted
value’. The programme was picking up momentum prior to the crisis:

●     Price investment was further strengthened through the launch of ‘Remarksable’
value and ‘Fresh Market Special’ lines, many at 65 pence. The level of promotions
also continued to reduce. As a result, the price index of comparable product baskets
has improved compared with key competitors, resulting in better price perceptions

●     A new programme of range innovation was brought forward including significant
launches in healthy, Plant Kitchen, made without, and family product to broaden 
appeal. This was combined with innovative new marketing including Little Shop and
Britain’s Got Talent sponsorship

●     5 ‘test and learn’ renewal Food stores were opened showcasing more of the 
full M&S range in a modern engaging environment and testing new product innovations
with encouraging results. We expect to move towards extension of these formats in
the coming year

●     Through Project Vangarde, which has now been rolled out to 90 stores, the 
leadership team has demonstrated scope for reducing waste, improving availability
and running stores more efficiently.

**Ocado Retail positioned strongly for growth**

During the year we completed the purchase of 50% of Ocado Retail providing M&S with
a profitable, scalable presence in online grocery, the UK’s fastest growing channel.
We reported a first time net income contribution for Ocado Retail to group profit
of £2.6m for the 7 months to 1 March 2020, with the early contribution reflecting
the limited period since completion. This is the contribution to group results prior
to switchover to M&S supply on 1 September, which we expect to drive volume growth
for M&S Food.    

We have been working closely with Ocado Retail to create a ‘one business’ mentality
which includes common operating procedures, business plan, and shared talent. Switchover
and synergy plans are on track. The value of the investment we have made has been
further reinforced by the strong growth reported by Ocado Retail since lockdown,
with growth for the most recent 9 week period of 40.4% reported at its AGM on 6 
May.

**Reengineering Clothing & Home**

The UK Clothing & Home business experienced a year of substantial reshaping under
new leadership, resulting in some encouraging performance indicators in the second
half. However, revenue declined 8.3% overall, with LFL revenue down 6.2%, including
an estimated 2.2% adverse impact from Covid-19 in March. Online revenue was level.
Operating profit before adjusting items declined 37.0%, largely driven by lower 
sales, gross margin headwinds related to sourcing and promotional mix and the impact
of the crisis.

Trading in the first half was affected by availability issues in Womenswear and 
in the second half by teething issues with the move of Menswear towards a more contemporary
style and fit. However, towards the end of the year, prior to the effects of Covid-
19, performance in Womenswear and Kids was encouraging, Menswear saw improving sales
trends and Lingerie held its market leading share.

●     In Womenswear, reshaping the buy and more contemporary style resulted in improving
performance up until the onset of the crisis. Recent range proliferation has been
reversed by  11% in Autumn/Winter and the focus on core strengths and hero categories
resulted in some strong uplifts. In denim the market leading position was extended
with a sales uplift of over 10% over two years

●     The successful launch of Goodmove resulted in increases in share of activewear
and growth in sales in this category of 16% in the three months post launch

●     Kidswear under a new leadership team started to reduce the breadth of range
and focused on stronger casual basics at better value resulting in LFL sales growth
in the second half

●     Menswear experienced initial problems with size and fit as the range migrated
towards a more contemporary style and look, in order to address issues in the shape
of buy. However, these issues should be non-recurring and we saw encouraging uplifts
for instance in knitwear, the standout category, with LFL sales growth of 5.6%

●     Lingerie market share held at 27%, and strong performances from ‘Collection’
as option count was marginally reduced

●     Online performance improved prior to the adverse impact of Covid-19 on trading
in March, but not as fast as expected and is being reorganised under new leadership
as part of the post Covid-19 programme.

**Changing the model in International**

The first phase of transforming the International business has been the move away
from direct ownership to a franchise and joint venture model, working with strong
partners in high potential territories. The focus now is on localising ranges, reducing
prices and will be increasingly on developing sales online globally.

International revenue at constant currency decreased 2.5%. Operating profit before
adjusting items declined 15.2% to £110.7m, largely as a result of trading conditions
in March.

The International online operation brings together operations in 44 markets including
direct shipments from the UK, sales on third party marketplaces and sales fulfilled
by franchise partners on their own websites. Online retail sales increased 26% to
£103m, supported by the launch of 5 new transactional websites and an expansion 
of ranges on marketplaces.

**Over £1bn of actions to reduce costs and manage cash under scenario planning for
Covid-19**

The Covid-19 crisis started to have an impact on the business in the first week 
of March with reductions in UK Clothing & Home sales which declined by 6.2% and 
26.9% the week after. With the onset of lockdown, the effect on sales, colleagues
and customers in both businesses has been dramatic. Clothing sales at the low point
dropped to 16% of their level a year ago. Without the resilience of the combined
Food and Clothing business model and extraordinary loyalty of colleagues the impact
on the business would have been even more profound.

**Covid-19 scenario**

Our belief has been from the outset that the direct impact of the crisis on sales
and stock flow will last through the year and that subsequent demand may be depressed.
In a challenging environment to forecast accurately the business is being managed
against a ‘Covid-19 scenario’ created in the early weeks of lockdown, which reflects
a very substantial reduction in sales, particularly in Clothing & Home and volatile
Food trading in the early months of the crisis. This scenario has been stress tested
and even in the event of a longer and deeper impact on trading, the group maintains
sufficient liquidity. Although we will be drawing on our available credit facilities
in the coming year, under the scenario the business will have significant liquidity
headroom throughout the next 18 months. We are pleased to note that in the first
6 weeks of the new year, sales and cash have substantially outperformed the scenario.

The scenario has the following core assumptions relative to our original FY 2020/
21 budget:

●     UK Clothing & Home, 70% decline in revenue for the four months to July and
only a gradual return to original budgeted levels by February 2021 impacting annual
revenue by c.£1.5bn 

●     UK Food, 20% decline in revenue for the four months to July, with revenue 
level thereafter, impacting annual revenue by c.£0.4bn

●     International – Clothing & Home revenue to follow a similar pattern to UK 
Clothing & Home with a significant decline in April due to closures, impacting annual
revenue by c.£0.2bn.

The table below sets out the revenue assumptions in the scenario by quarter showing
variance to original budget.

| % change to budget | Q1 | Q2 |  Q3 |  Q4 |            FY | 
| UK Clothing & Home | -74 | -61 | -40 | -6 |             -46 | 
| Food | -20 | -6 | – | – |               -6 | 
| International | -51 | -20 | -9 | -9 |              -22 |

In the light of the prolonged partial or total lockdown envisaged in our Covid-19
scenario, we have taken actions totalling c.£1bn relative to original budget to 
reduce costs and manage cash, while protecting our transformation plans and trading
potential.

**Substantial cost reduction of c.£500m in FY 2020/21**

●     Non-essential spending has been reduced at all levels. For instance, we expect
Clothing & Home marketing to be down c.£50m for the year, pay levels and recruitment
have been frozen saving c.£40m and technology costs will be down c.£40m

●     Costs which are largely related to sales volume are being managed down, for
instance Clothing & Home logistics down c.£60m, colleague costs post lockdown saving
c.£40m and International costs saving c.£30m

●     Fixed property related charges are expected to decline with service charge
reductions, rent costs and other occupancy cost savings down by c.£20m before any
more far reaching changes to the store portfolio

●     Government support measures including business rates relief of c.£172m and
the job retention scheme of c.£50m will further support this year’s outcome.

In addition to these savings we are exploring the potential for other changes, including
a more streamlined support centre, changes to leadership structure and negotiations
with landlords on commercial terms on lease contracts.

**Actions to stabilise cashflow exceeding £500m**

In view of the steep increase in working capital resulting from unsold stocks we
are experiencing a cash outflow during the lockdown period and expect to draw on
our credit facilities in the months ahead. Under the Covid-19 scenario, drawings
are estimated to peak in early Autumn at c.£600m, although our current performance
would suggest a lower figure. To reduce risk, maximise liquidity, and enable a return
to growth in the future steps have been taken to underpin cash flow and reduce working
capital.

●     Capital expenditure for the year has at this stage been reduced to c.£140m,
saving c.£195m in cash outflow in the current year against budget. Only essential
and short payback investment focused on growth has been retained such as the new
ambient food depot, investment in online fulfilment and site development and the
digital & data programme

●     Cash management initiatives including in-year deferral of corporation tax,
VAT and duty payments and likely savings from lower corporation tax paid for 2020/
21

●     As previously reported, there will be no final dividend for 2019/20 and the
board does not expect to pay a dividend for the current financial year, using the
funds instead for balance sheet support in the region of £340m.

**Liquidity and additional headroom secured for 2020 and 2021**

It was an immediate priority for the company to secure its debt facilities to provide
for the cash requirements modelled under the Covid-19 scenario described above and
given the risk in an uncertain market to ensure there is downside protection under
even more adverse sensitivities. Therefore:

●     Formal agreement has been reached with the syndicate of banks providing the
£1.1bn revolving facility to remove or substantially relax covenant conditions for
the tests arising in September 2020, March 2021, and September 2021

●     We have confirmed that we are eligible to access funding under the Government’s
Covid Corporate Financing Facility and been allocated an issuer limit of £300m

●     As a result of these actions we expect to have considerable headroom under
our available facilities in FY20/21. While we will experience a cash outflow in 
the first half of the year as sales reduce and we pay for our previous stock commitments,
we would expect this to partly reverse in the second half of the year

●     Under the Covid-19 scenario, drawings against our available facilities would
be in the range of £300m-£350m by the end of 2020/21

●     The cancellation of the final dividend of c.£130m will generate further cash
savings after year end.

Experience to date has been ahead of the Covid-19 scenario against which we set 
strong cost and cash management plans and has outperformed the scenario by over 
£150m year to date, with actions planned to further improve our cash flow. If sustained,
under the Covid-19 scenario we consider the Group well positioned to exit the crisis
with limited drawdown against its facilities in 2020/21, with a further saving of
the final dividend in the early months of next year. We intend to adopt a dynamic
approach to investment using sustained cashflow outperformance to capitalise on 
strong investment opportunities under our ‘never the same again’ agenda.

**Management of excess Clothing & Home stock**

Like all fashion businesses one of the biggest challenges arising from the crisis
is the mounting backlog of unsold stock for Spring/Summer 2020 and the forward pipeline
of stock already ordered for Autumn/Winter. We closed 2019/20 with Clothing & Home
stock of c.£500m and at that time had committed forward orders of £560m scheduled
to arrive in the following six months. As the lockdown eases a large proportion 
of current season stock will remain unsold and demand for many categories is likely
to be weak. We have acted quickly to improve this position.

●     We have cancelled late summer stock which will no longer be required reducing
forward commitment at cost by £100m

●     Of the balance of stock and forward orders c.£400m is year-round basic product
where M&S trades strongly and which will be carried forward at low risk, albeit 
creating a short-term increase in stock carrying levels

●     Of the unsold seasonal stock, we have made arrangements to hibernate around
£200m until Spring 2021, secured storage facilities and planned for the cost of 
these actions

●     We have therefore taken a charge of £145.3m in adjusting items to reflect 
the cumulative impact of the combined handling, clearance, hibernation and write-
off of the stock bulge described above.

The combined impact of lockdown, social distancing and depressed demand is therefore
likely to continue through the year.

Never the Same Again

During the crisis we have all had to work differently and customers have rapidly
changed habits and may never shop the same way again.  We intend to use the learning
from the crisis and have drawn up our ‘_never the same again’_ agenda to accelerate
transformation.

**What we are learning in the crisis**

The crisis illustrated how differently we can use technology, run stores, and make
decisions fast. In a business with a history of slow cultural change we intend to
use these lessons, to ensure that as lockdown eases, we are never the same again
in culture, organisation and work habits. For instance:

●     A smaller top team has made decisions faster and more efficiently delegating
trading and operating management to business unit heads. Numerous working groups,
committees and elaborate management processes have been disbanded

●     Support colleagues have learnt to improvise their routines at lower cost with
no detriment to trading standards

●     Our strategic relationship with Microsoft has been highly effective, supported
by Teams

●     In stores given the need to furlough and redeploy colleagues, valuable lessons
have been learnt about our ability to multi-task and increase the pace of work with
no adverse impact on service

●     Online has for a period been our only significant Clothing business and has
illustrated the need to be leaner and more integrated to compete with online pure
plays

●     The reduction in forward order volumes in Clothing has forced the need to 
change ranges to buy more of less from fewer core suppliers.

What will never be the same again

Steps have already been taken to ensure that the change of gear of the last few 
weeks endures, including the following:

●     Steve Rowe has already announced changes to the business leadership structure
with the formation of a small executive board consisting of the operating MDs together
with Katie Bickerstaffe who has now started as Chief Strategy & Transformation Officer,
and Eoin Tonge Chief Finance Officer who is arriving in early June

●     Central support costs and headcount will be examined at all levels, delegating
decisions to business unit and category heads

●     In stores, multi-tasking and more flexible management structures will be integrated
into the way the business works and manages

●     Digital is being consolidated under a single transformation team bringing 
together data, online development and technology

●     The direct to the front-line tech enabled communication combined with increased
flexibility in working patterns will become permanent.

**Accelerating the transformation programme**

●     The move to ‘trusted value’ in Clothing & Home will be accelerated and option
count reduction and supplier concentration brought forward

●     The reduction in range and shift towards fast moving product at great value
necessitated by the crisis will result in a permanent reduction of 20% in Autumn/
Winter store option count

●     The role of the sourcing offices will be increased so that sampling, ordering
and quality issues are dealt with offshore

●     A faster, ‘near-sourcing’ supply chain will be developed, to enable the test
and re-order of seasonal fashion lines particularly for the online business

●     The replacement of ageing stores already underway and shift in relationships
with property providers will accelerate

●     The longstanding issues with availability and waste in the Food supply chain
will be tackled with the roll out of the Vangarde programme and addressing the contract
and relationship with Gist.

**Becoming an Online winner in C&H and Food**

Customers may never shop the same way again. The sharp growth of online grocery 
during the crisis is evidence of this as is the strengthening performance of our
online Clothing & Home. 

The Ocado joint venture relationship is an integral part of our strategy to bring
M&S Food into the online and home delivery market which we expect to be even more
vibrant as a result of the crisis. Since the formation of the joint venture Ocado
Retail has performed strongly and following lockdown, revenue in its most recently
reported 9 weeks to 3 May was up 40.4%.

The Food business is now working closely with Ocado Retail to ensure that it has
a compelling offer at the switchover from the Waitrose supply contract on September
1st.

●     Adding over 6,000 M&S lines to Ocado from September compared with just c.4,000
Waitrose lines which will be removed from the site. We believe M&S has substitutes
at the same price or lower, and of the same quality or better, for the majority 
of the current offer

●     Finalising product data sets for online trading, supply chain processes for
direct to Customer Fulfilment Centre deliveries and switchover procedures for September

●     Negotiating supplier terms and other working arrangements to deliver synergies
for M&S starting this year and building to not less than £70m in 36 months from 
inception of supply

●     Agreeing through Ocado new supply agreements with major branded suppliers 
to improve M&S competitiveness in branded sourcing

●     Bringing onto the Ocado Retail platform around 1,600 core Clothing & Home 
lines per year to be available on the site, providing a further route to market 
and a customer acquisition channel. The Autumn range will be launched in September
with c.850 lines made available.

In addition, in Clothing & Home, the M&S.com and large stores platforms will be 
opened to complementary guest brands to broaden appeal and increase online growth.

**Further strengthening the management team**

We have created a significantly renewed management team, to implement the “never
the same again” agenda.  In the coming weeks the new team will finally take shape
with a number of important new arrivals:

●     Katie Bickerstaffe has joined as Chief Strategy and Transformation officer

●     Eoin Tonge joins as CFO in June

●     Richard Price joins as Managing Director, Clothing & Home in July

●     Will Smith joins as Property Director in May

●     Stephen Langford joins as Head of Clothing & Home online in May

●     Helen Milford joins as Store Operations Director in June

●     Paul Babbs joins as Head of Clothing & Home supply chain in May

●     Craig Lovelace joins as Finance Director of Food in June

**Recent trading performance**

The first six weeks trading has been ahead of the Covid-19 scenario particularly
in Food and online. 

●     Store sales in UK Clothing & Home were reduced to a trickle due to the closure
of space running down (98.8%) year on year at the low point. In store sales of essentials
increased from £252k per week in the first week of lockdown to £1.4m per week by
week six

●     Although online Clothing & Home has traded throughout, demand in the initial
weeks for clothing was very low with a gradual uplift since. In the last 3 weeks
online sales have been running c.20% up year on year

●     Standalone Simply Food stores have traded strongly, up 17% with a positive
trend in many Retail park stores which typically have direct access from car parks.
In the earliest weeks of lockdown this was offset by lower sales in travel franchise
units (c.5% of revenue) and the closure of in-store hospitality and cafes (c.4% 
of revenue). In the last three weeks overall Food sales have on average been level.

●     Marks & Spencer also experienced an initial adverse margin mix as demand shifted
towards ambient grocery sales, although this is now diminishing.

| **% change to LY\*** | **6 weeks to 9 May 20^(1)** | 
|  Clothing & Home | -75.0 | 
| Food | -8.8 | 
| International | -51.3 | 
| **Group** | -32.7 | 
| Clothing & Home.com | 6.4 | 
|  M&S.com | 19.9 | 
| Food ex hospitality | -4.6 |

_1. unaudited revenue for the 6 week period from 29 March 2020 to 9 May 2020_

_*At constant currency_

Share on: