We undertake a deep dive of the food and clothing retailer to see why analysts are starting to like Marks & Spencer

According to chief executive Steve Rowe, a 35-year veteran of Marks & Spencer (MKS), the venerable retailer is roughly at the halfway point in its three to five-year journey of transformation to ‘restore the basics’ and create a ‘profitable, growing family of businesses’.

However, true to his nickname of ‘Nails’, he pulls no punches in assessing the scale of the task. When he took over in 2016, the business suffered from ‘a bureaucratic culture which had never been challenged’, was ‘behind the curve in digital and tech’, was ‘operationally weak and drifting upscale in Food’ and had ‘lost its style and value identity in Clothing & Home’. Moreover the store estate wasn’t fit for the future and its supply chain was expensive and outdated.

In this year’s first-half results, Rowe described M&S as having achieved ‘far-reaching change – delivered at pace’ and claimed that change was happening ‘faster than at any time in my career’. Yet judging by the performance of the share price, it still isn’t fast enough for investors.

We would argue that the food business, the biggest earner, is back on track, and the joint venture with online delivery firm Ocado (OCDO) is a genuinely bold move. Management now needs to take a similarly bold line with the clothing and home business, and we have a couple of radical suggestions.

THIS IS MORE THAN JUST A MAKEOVER

To help break up the bureaucracy and reshape the organisation, Rowe brought in a raft of new leaders starting in September 2017 with chairman Archie Norman.

As well as an extensive retail and business career, Norman had overseen successful transformations at supermarket chain Asda and broadcaster ITV (ITV). He was joined by Humphrey Singer, former chief finance officer of electrical retailer Dixons Carphone (DC.), in July 2018, and Justin King, ex-chief executive of grocer J Sainsbury (SBRY) and a former head of the food division at M&S, who joined as a non-executive director in January 2019.

The job of making the property estate ‘fit for the future’ is a much tougher fix than changing the management culture as a third of M&S’s full-line stores were built before 1939 and three quarters are over 25 years old.

To its credit M&S has been busy reshaping the estate. In addition to the 35 full-line stores closed in the 2018-19 financial year, in the six months to the end of September 2019 a further 17 full-line stores, two outlets and one food store were closed. Happily, nearby stores have seen an increase in sales with transfer rates approaching 20%, and more closures are planned for this calendar year.

Meanwhile spending on remodelling UK stores increased significantly in the six months to September 2019, hitting £22.8m against £6.8m in the same period the previous year. One of the regular complaints in customer surveys is that the stores are confusing and hard to navigate.

At the same time the firm is bearing down on operating costs with a programme to reduce outgoings by £350m ranging from central costs to warehousing and distribution to in-store costs including staffing.

UPGRADING THE SUPPLY CHAIN

As well as reducing and modernising its store estate, M&S has reduced the complexity of its supply chain network by closing four distribution centres and warehouses and opening a national centre at a former Tesco (TSCO) site in Welham Green in Hertfordshire, operated by DHL.

It has also beefed up capacity at its Donington warehouse facility and introduced a new warehouse management software system across the group with the aim of up speeding up replenishment to stores and reducing levels of stock holding by up to four weeks.

A part of the effort to reduce what it calls ‘clog’ in its stores, excess stock is removed from display and sent back to the warehouses making the stores less cluttered and easier for shoppers to navigate.

FOOD SALES GROWING AGAIN

We would argue that the changes made to the food business, especially the focus on everyday value and family appeal, are already bearing fruit. For the first time since 2015, like-for-like sales growth has been positive for three consecutive quarters.

Key drivers of this improvement have been the move away from ‘overly premium’ ranges and confusing promotions, better timing and scope of markdowns, and above all changing the in-store message to communicate value as well as quality.

There have also been changes behind the scenes, with effort going into shortening product development times, improving communication with suppliers, increasing collaboration and speeding up decision-making.

Meanwhile a reduction in space for ‘ambient’ (packaged) foods is expected to generate cost savings of as much as £20m.

Unfortunately, food waste, which is amongst the highest in the industry and has historically been a problem at M&S, was again an issue last quarter with over-ordering of Christmas products. Better forecasting and communication with its logistics suppliers is needed.

This year also sees the operational start-up of the joint venture with Ocado to deliver online food orders. By combining the strength of its brand with Ocado’s online offering, M&S hopes it can directly target the 12m M&S food customers who currently shop for food online with its competitors as well as picking up most of the existing Ocado customers who currently use the service to buy Waitrose products.

SIGNS OF IMPROVEMENT IN CLOTHING

While the food business has turned up, the clothing and home operations are still racking up negative like-for-like results and sales continue to dwindle despite numerous attempts to stem the tide.

The UK clothing market is worth an estimated £35bn per year and M&S is still the UK’s number one clothing retailer with over 23m customers. When it comes to essentials like bras and children’s school uniforms it dominates the market, and a renewed focus on ‘must-haves’ seems to be working with womenswear sales outperforming the market in the latest quarter.

Historically, size ratios have been ‘misaligned with the profile of the contemporary family-age customer we aim to appeal to’ according to Rowe. Where management has reshaped its buying by introducing fewer options with slimmer fits and more mid-sizes, the customer response has been ‘very strong’.

Many of the sub-brands such as Per Una and Blue Harbour are being ‘edited’ and relaunched, and a new pricing philosophy of ‘first price, right price’ aims to cut the amount of products sold at a discount.

There are also innovations, such as the new Goodmove ‘athleisurewear’ range targeted as customers who either work out regularly or like to wear athletic wear on a casual basis. The UK athleisure sector is estimated to be worth £3bn per year and GlobalData predicts it will grow by 20% per year to 2023, making it an attractive market.

The clothing business still suffers from slow stock replenishment and on occasion depth of buy, selling out of popular lines too quickly, and it still hasn’t arrested the slide in menswear sales, but our sense is the like-for-like performance is improving. A reduction in the amount of stock held going into sales is also helping to lift margins.

RADICAL THINKING REQUIRED

The area we struggle with is the home products business. M&S refuses to break out sales figures or margins, and requests to leading analysts for their estimates of the business split were ignored suggesting that they don’t know. Our best guess is that ‘home’ accounts for a good deal less than half of the broader home and clothing division’s sales and earnings and like-for-likes are considerably worse than the clothing business.

Given the long list of heavyweight high street and retail park competitors for home products, such as Argos, B&M European Value (BME), Dunelm (DNLM), Ikea, Matalan, Wilkinson and even the supermarkets, and an endless list of online suppliers, we fail to see why M&S feels the need to operate in this market. Gross margins may be higher than food, but turnover is much lower and the amount of space given over seems disproportionate.

We would suggest scrapping home sales altogether and focusing on an area where the brand offering is weak and needs improvement – footwear. In fact we would go a step further and suggest that M&S acquires Clarks, which is in the process of restructuring its operations, shutting many of its 550 UK stores and turning its focus to the Far East.

Founded 195 years ago, Somerset-based Clarks was voted the UK’s number one fashion brand in a summer 2019 poll of Britain’s favourite brands by YouGov (YOU:AIM), ahead of global giants Adidas and Nike. Those polled trusted its brand and praised the quality of its products.

Despite the family-owned firm’s popularity, group turnover fell 5% to £1.46bn in its last financial year and it reported operating losses of close to £30m against profits of £75m the previous year due to ‘onerous leases’ on its high street operations.

Putting the trusted Clarks brand alongside Marks & Spencer’s food and clothing offering would constitute a formidable proposition in our view. Adding footwear would not only give customers another reason to visit M&S stores, we believe it would increase margins in the clothing division.

Hopefully Richard Price, the current chief executive of F&F (owned by Tesco) who has been drafted in as the new managing director of the clothing and home division, is prepared to take bold decisions and steer the business in a new direction rather than simply tinker at the margins like his predecessors.

INTERNATIONAL BUSINESS UNINSPIRING

M&S has exported and sold food and clothing abroad for more than half a century, yet the business still only represents around 10% of group turnover.

Its track record in international markets is inconsistent. After a string of misjudged acquisitions and roll-outs it pulled out of the US and Europe in the early 2000s, only to expand again in 2011. Five years later, after another strategic review, it upped sticks in 10 overseas markets and now operates through franchise and joint venture partners who generate the bulk of sales and earnings.

Following a poor performance in the 2018-19 financial year, international sales in the six months to September were down 1.7% and the slide continued in the third quarter with sales down 2.3%.

Despite optimism over India, where M&S has upgraded its existing stores, rolled out new ones and launched new beauty and lingerie ranges tailored to the local market, the international business seems unlikely to make a major contribution or ‘move the needle’ for the group in the next few years.

BUILDING A DIGITAL ‘LAKE’

By its own admission, M&S is playing catch-up in terms of the digital market. There has been progress with the M&S.com website, which boasts 11m users, in the form of faster average page-load speeds, and the firm has explored social media ‘piloting’ with a shoppable feed on Instagram.

In the 2018-19 financial year, 22% of clothing and home sales were online and clothing sales are growing faster than the market. Next to come are later cut-off times for click and collect, trials of same-day delivery, faster payment speeds and a mobile M&S app targeting over 1m users. The aim is for a third of clothing and home sales to be made online.

However the Sparks loyalty card, which has 7m users, has been an undisputed flop and needs rethinking. Sparks customers tend to spend significantly more than other M&S customers and their click-through rate online is 50% higher yet the lack of a clear ‘value exchange’ has curbed its appeal.

In theory, across Sparks, its website, its bank and soon its Ocado joint venture, M&S has the potential to create a huge ‘lake’ of customer data which it can use to personalise the shopping experience and increase customer loyalty.

In practice, it has underinvested and the organisation isn’t digitally joined up, meaning it has a long way to go. At least it has confronted the problem and knows what it needs to do.

EVOLUTION OR REVOLUTION?

M&S has the potential to become a bigger, better, more profitable business if it can tackle the issues over which it has control. With the election out of the way and ‘Brexit uncertainty’ no longer an excuse, consumer spending is likely to pick up in 2020 and retailers should be obvious beneficiaries.

The share price is close to decade-lows and discounting weak sales for the foreseeable future. If Steve Rowe and his team are up for making bold decisions, we think M&S could transform its proposition and its sales by realigning the clothing division, otherwise it looks like a slow grind back to growth.

Almost half of the brokers (nine out of 21) with a view on M&S have no view, ie. they have a ‘hold’ recommendation, with the rest split equally between ‘buy’ and ‘sell’. Berenberg, which was slightly premature in moving from ‘sell’ to ‘buy’ ahead of the third quarter results, believes that easy like-for-like comparisons and Price’s arrival will lift clothing and home like-for-likes this year.

On the other hand analysts at Liberum say ‘sell’ on the basis that pricing and margins in the food business could come under pressure and clothing and home still isn’t fixed. ‘We acknowledge the changes being implemented but are not yet convinced that these will materially improve the fundamentals.’

M&S could continue to plough on with its five-year plan to increase sales and earnings but as the share price suggests investors are losing heart. If it were to take bold action we suspect analysts and investors would back it but buying the shares today feels like a leap of faith given the dire commentary about the UK retail sector.

 

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