The first half-year to 30 September was significantly better-than-expected for Marks & Spencer Group (LSE:MKS) – but as management concedes, for how long can it last?
Trading momentum was maintained through October. However, “the outlook remains uncertain with the probable impact on consumers of the highest interest rates in 20 years, deflation, geopolitical events and erratic weather”.
A macro trait that I would note - but not follow slavishly - is the largest one-year drop in UK money supply since 1922, when a slump followed economic boom after the First World War.
The broad measure of money – what households and businesses have on hand to spend – is down 4.2% over the last 12 months, much greater than the aftermath of the 2008 crisis.
Given the UK economy has also stagnated over the past year, it raises the risk of recession, hence some adjustment in consumer behaviour. At least M&S’s food side should remain resilient unless customers cut back on pricier items and/or trade down.
Economic theories get perplexing: the implication is that the UK now risks a deflationary trap, when up to now the message has been stagflation - where inflation remains sticky (due to wage increases and labour shortages) yet the economy moribund.
Monetarism suggests a fall in inflation or economic activity or a mix of the two. This should at least be borne in mind by holders of consumer-related equities. Such theory is not necessarily useless if “disproven” by events as other factors could have predominated.
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For example, available cash may be falling as savers re-allocate from zero-interest bank accounts into bond funds and the like, after rates have risen but current accounts offer no return.
Also, the September 2022 mini-budget meant some funds liquidated assets to generate cash but have since reversed this trend. Yet even adjusting for this, UK money supply is falling.
From ‘deep value’ play to turnaround affirmed
I first made a “buy” case on M&S at 88p in May 2020 based on a 30% discount to net assets, re-iterating my view at 96p that November. The discount was significantly a function of M&S’s clothing side struggling to evolve from reliance on essentials and formal wear, yet it offered a margin of safety to tuck the stock away and potentially get lucky.
The last financial year to 1 April beat expectations, with sales up 10% and net profit by 17%. Yet even when declaring this last May, sentiment appeared still to be jaundiced after years of mixed financial results. My optimism was based on the fact it would only need steady improvement in operations for M&S equity to rise.
Despite May’s caution about higher energy costs and the need for staff pay increases, the normalised first half-year operating margin has risen from 5.1% to 6.7%. A structural cost-reduction programme – while also investing in customer service and digital development – is helping.
Comparing Sainsbury (J) (LSE:SBRY)’s, which has a substantive “home” side after its 2016 acquisition of Argos, its operating margins have trended only at 2% to 3% over the last six years, with Tesco (LSE:TSCO) marginally higher at 4%. The financial summary table for M&S shows it sustaining over 5% at the reported level, hence with revenues kicking in, this boosts profitability.
Marks & Spencer Group - financial summary
Year-end 1 April
|Turnover (£ million)||10,555||10,622||10,698||10,377||10,182||9,167||10,885||11,931|
|Operating margin (%)||5.5||2.4||1.5||2.9||2.5||-0.4||5.3||5.2|
|Operating profit (£m)||584||253||157||298||255||-37.5||578||620|
|Net profit (£m)||407||117||25.7||41.7||23.7||-198||309||363|
|Reported EPS (p)||23.7||6.9||1.5||2.5||1.2||-10.1||15.1||17.9|
|Normalised EPS (p)||37.4||36.1||36.8||37.0||22.1||4.5||20.8||18.2|
|Earnings per share growth (%)||16.2||-3.4||1.9||0.4||-40.3||-79.8||366||-12.6|
|Return on total capital (%)||9.2||4.3||2.7||4.6||3.1||-0.6||8.2||9.7|
|Operating cashflow/share (p)||70.6||62.6||49.9||73.1||50.1||44.6||67.8||50.6|
|Free cashflow/share (p)||38.5||38.6||29.4||54.8||32.8||34.0||55.2||30.5|
|Dividend per share (p)||17.9||17.9||17.9||13.6||3.9||0.0||0.0||0.0|
|Covered by earnings (x)||1.3||0.4||0.1||0.2||0.3||0.0||0.0||0.0|
|Net debt (£m)||1,806||1,747||1,575||3,802||3,813||3,355||2,546||2,547|
|Net assets/share (p)||203||186||174||152||190||117||149||143|
Source: historic company REFS and company accounts
Mind how food price inflation will have significantly helped an 11% hike in interim revenue to over £6.1 billion. Yet despite the share of Ocado losses rising from £8 million to near £47 million, operating profit jumps 83% to £315 million.
The group’s national network of factory outlet stores in retail parks is also a useful dynamic, where last year’s fashions are available at half-price, and this introduced new customers to M&S. It provides a “value” angle to compete with discount retailers without diluting a reputation for quality.
The balance sheet debt/cash mix is a bit odd, modestly affecting the income statement. September’s balance sheet had £3.3 billion of financial debt versus £829 million cash, with the cash flow statement showing £268 million redemption of medium-term notes. It means £102 million interim financial income offset by £92 million cost. Pre-tax profit still advances an impressive 56% to £326 million.
Net profit of £207 million compared with £384 million consensus for the full year to April 2024, hence an upgrade to £401 million in the last day or so. Mind how management cautions profit is expected to be weighted to the first half of the year, partly due to macro challenges but also increased investment in the second half.
New CEO looks to have been an essential catalyst
Despite progress on the food side in recent years, M&S’s financial reporting tended to get let down by clothing being perceived as out-of-touch with modern tastes. Lately, around Covid, a strong element of formal wear meant revenue suffered from event cancellations.
Yet various critics have now become fans of the designs, “M&S clothing holds leading scores for quality, value and style,” we’re told, and specific ranges for women and holidays have enjoyed revenue rises in high-teens percent. Since last summer, M&S has led UK market share in womenswear.
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Not to disregard middle management’s effort here, but it appears to show how a vigorous CEO can initiate culture change with far-reaching effects.
Stuart Machin joined M&S in May 2018 with a mandate to revive its food side, which proved a resounding success. He takes a grassroots’ approach, for example on becoming CEO from May 2022, launching a Straight to Stuart scheme, enabling staff to share views on improvements.
Relative to highly educated managers nowadays, he is a hands-on pragmatist, having joined Sainsbury’s as a teenage shelf-stacker and also worked at Tesco, Asda and Coles of Australia in increasingly senior roles. He is getting results where legions of strategic consultants and the like failed.
Yet he declares: “We’re only just beginning. Lots done, lots to do, lots of opportunity.”
On company-specific criteria, the stock remains a ‘buy’
It is increasingly clear the long-awaited turnaround at M&S has traction – the key factor for long-term investors.
This was underlined by a non-executive director buying £123,500 worth at 247p as soon as the restricted period on dealings was lifted. Despite being an initial purchase after her appointment last February – non-executive directors being encouraged to hold equity – it is a material commitment implying belief in value.
The stock has settled back at 243p as the positive surprise element fades and markets re-focus on interest rates liable to remain elevated to tackle inflation. Macro will indeed be a key determinant in the medium term.
Yet M&S traded at over 250p in early 2022 and has declined from around 550p in mid-2015. The group’s overhaul implies good potential for its stock to double given favourable conditions.
Net profit towards £450 million implies a modest price/earnings (PE) multiple around 11 times and consensus looks for a near 6.5p dividend in respect of the April 2025 year, implying the yield to edge up to 2.7% from 1.8% for 2024.
With Tesco and Sainsbury’s offering more like 4.5% to 5.0%, if sentiment eases towards UK retail stocks in a recession, M&S has the comparatively weaker yield prop.
On current macro considerations, more like a strong ‘hold’
If you agree with me to respect macro trends – at least in the short term – then with fresh money you would applaud M&S’s progress, but wait. I would still be inclined not to take (some) profits to manage risk, unless you have a particularly dire outlook. A two-year view continues to favour upside. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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