Marks and Spencer Group plc (MKS) Earnings Call Transcript & Summary

Hello, and welcome to the Marks and Spencer Group fixed income investor call. I'll shortly be handing over to Eoin Tonge, who will introduce the call. So Eoin, please begin.

Thank you, and good afternoon to everyone, and thank you for joining our call. My name is Eoin Tonge. I'm the, I guess, relatively new group CFO. I joined at the beginning of June, and so I'm glad to be here today to present my first set of results. I'm here with a few members of my team, Dan Brook, our Group Treasurer, whom I think you all know; and Fraser Ramzan, who runs our Investor Relations also and a few other members of our team. I'm going to quickly just give a quick -- just a quick update in terms of the messages from our announcement this morning. And then hopefully, we'll just move on to Q&A. And I think -- our belief the results in the half year period, we're pretty good in the context of the COVID environment that we're operating in. And overall, group sales were down nearly 16%, and the group did record an adjusted loss before tax as a result. I think there were different messages and different impacts in different parts of our business. So if I start off with Food, in general, we had a very good performance in Food. Sales were broadly level overall. But within that, when you take into account the fact that a lot of our hospitality was closed for a long period of time during the period, we had actually like-for-like of 6.6%, which was a really good performance and reflected a move to medium-type baskets, which is underpinned by some of our value propositions that we've really driven hard during the lockdown and I think puts us in good stead for the next period of lockdown and beyond. Overall Food operating profit increased 19%. We did see adverse gross margin mix impact driven by lower hospitality and convenience sales, but that was more than offset by lower cost, which included efficient staffing across our stores and reduced marketing costs as well, of course, the benefit of business rates relief. Our share of net profit for Ocado Retail was GBP 38.8 million in the period. So obviously, a very strong performance. As already reported by Ocado Group, revenue was very strong in the period, reflecting strong demand for online through the crisis and as well as that a strong operational performance by Ocado Retail. In Clothing & Home, the revenue, obviously, decline of 40% reflects both the Q1 effective lockdown, where a lot of our stores were actually closed for a long period of that Q1 and a gradual improvement in Q2. Online sales, in particular, was strong, and we were very happy with the performance of our online all the way through the period, particularly in the second quarter, and that was supported by strong demand for casual categories, Kidswear, Home, and it was supported by lower return rates. Overall, Clothing & Home had an operating loss of GBP 108 million. At a headline view, obviously, while online profitability increased, it was insufficient to offset the decline in store sales. I think one of the strong stories of our first half was our performance in cash and cash flow. You will remember -- I wasn't here, but you will remember my colleagues at the beginning of the year thinking that we might have to draw on our credit facilities of up to GBP 650 million. In fact, actually, we generated cash in the period and net debt fell by 3%. So a really, really strong performance. Obviously, that was driven by better-than-expected EBITDA, which was driven by better sales performance in Clothing & Home in particular than expected. And there were some other points. Firstly, we had a strong working capital performance, reflecting a whole heap of activities across our business and in particular, focusing on our supplier terms in Clothing & Home. We did spend less on CapEx in the half, which, as you'd expect, we would as we constrained investments while we worked through the crisis. So as a result of the half year generation, we have approximately GBP 1.4 billion of cash and undrawn facilities at the half year, which we're very happy with, puts us in a good position for how we think about ourselves from a liquidity perspective, particularly as we look into the next few months of disruption brought about by the second lockdown and indeed, our cut over into Brexit. So I think that's -- they're the high-level messages. I'm more than happy now to hand over to questions and take -- and go into a bit more detail. Thank you.

[Operator Instructions] Our first question is from [ Ella Cottola ] at JPMorgan.

I have a couple please. The first one is around the working capital, specifically on the inventory. The balance sheet demand seemed to be going up about GBP 100 million from March levels. But in the cash flow from operations, the working capital detail shows about a flat or plus GBP 8 million increase. Can you explain the difference, please? The second one is, you mentioned that there's been an extension of payment terms. Can you quantify that impact? And can you also tell us if there are any other deferred payments or reversals that we should see in the working capital? And then finally, with respect to CapEx, would you be able to give us a guidance for the full year? And if you can comment on the -- sorry.

Ella, what was the last? I didn't quite catch what was that, guidance for the full year?

Yes. Full year CapEx, and then if you can comment a bit on the profitability of the online Clothing & Home compared to the stores, that would be great as well.

Okay. Excellent. Well, look, some good questions, Ella. So firstly, on the stock difference between what's in working capital and balance sheet, I mean, that's all to do with provisions and FX. I mean in simple terms, that's the simplest way to think of it. So we've had a really good performance on stock in the first half. Clearly, it would have been a concern as we ended last year and went into the lockdown. We cut back on a lot of stock orders and canceled quite a lot of stock orders and brought our stock balance into a better shape. But also, actually, we actively sought to clear stock through the period through promotion and through discounting, largely supported by our Rainbow Sale, which took place through large parts of the summer. So overall, we feel we've actually done an excellent job on getting our stock into a good place, particularly now as we kind of walk into autumn and into Christmas period and indeed to a second lockdown. You will see our stock level at the end of March -- sorry, at the end of September, is more than GBP 100 million less than what it was this time last year, obviously reflecting lower levels of sales, but obviously also reflecting the fact that our stock position is in a better place. In terms of payment terms, yes, I think there's -- let me answer your second part of your question first, which is I think there's actually a lot to go after in working capital optimization actually across the group. I think one of the sort of learnings from the crisis is that we probably haven't optimized working capital as much as we possibly can. I think there's plenty to go after in terms of stock in Clothing & Home, particularly as we reduce option count. There's plenty to go after in terms of payment terms, both in Food and Clothing & Home and in goods not for resale, and a little bit in decors, although there's not a huge amount in decors given the shape of our business. So this is a big area of focus of mine, actually. I'm very much a kind of a cash-focused type CFO, just so you know. And I think there's plenty to go after. The quantum impact, about half of the working capital benefit that we got in first -- sorry, in that first half was to do with extension of payment terms. That's an extension of payment terms of 120 days with our primary clothing home suppliers. I think some of that -- I don't think that's completely sustainable, just to be clear. But a lot of the measures that I've said is -- that I just noted in terms of working capital, I think although we might keep that for a period of time and maybe look to bring it back a little bit, there's a lot of optimization to be done. I do not expect that working capital benefit that we saw in the first half to unwind. In terms of CapEx for the full year, I think we said at the end of last year -- last -- sorry, end of the financial year, started this financial year, that we estimated to have about GBP 140 million of CapEx. For the year, you'll see in the first half towards about GBP 75 million of CapEx accruals from last year that hit the cash flow in the first half. Our current estimate, which will depend a little bit on timing, but our current estimate is still to have that level, i.e., GBP 140 million plus GBP 75 million for the full year. And in terms of online profit, we don't split out online profit. I mean we'll talk a little bit about what we've announced in terms of MS2, but online is very much a division within Clothing & Home. And as a result, it's hard to kind of disaggregate some of the shared costs around buying and merchandising, et cetera, and so on. But I can say that the operating profit before sort of essentially allocated costs was very strong in our online business and actually would easily compare favorably with any sort of pure-play type of businesses. So that's one thing we're very happy with at the moment.

Can I just have 1 follow-up? Given that you've talked about all the potential improvements in the working capital then for the full year, shall we expect working capital to be an inflow?

Yes, we should do. Yes. I mean, basically, the GBP 75 million inflow in the first half, I'm not expecting that to unwind in the second half. And in fact, I hope to do better.

We'll go to the next line, which is Chris Roberts at BNP Paribas. [Operator Instructions]

I think in the statement this morning, you suggested that over time, you'd look to get the balance sheet back into sort of investment-grade context. Is there anything a little more concrete that you can provide to us on that, i.e., the [indiscernible] net debt that you'd like to get to or some kind of reported leverage range or target just to help quantify our understanding of that, that would be helpful? And then the second thing is, and apologies if this is a sort of basic question. Could you just remind us how we should think about the cash contribution, if any, on the Ocado JV? Because my understanding is that actually the cash contribution is, as it were, minimal.

Yes. Okay. Yes. Thank you, Chris. Yes. Why don't I just deal with the second part of your question first, just to get it out of the way? I mean the way Ocado works is, effectively, it's an investment, so it's a separate entity. So we're -- we don't get cash per se from Ocado. There is a cash element in the cash flow, but that's to do with the tidy up of the acquisition. So that, you can almost kind of ignore that because that's obviously not going to happen again. And so the way Ocado works is obviously, it will generate some cash, and then that cash sits on the Ocado retail balance sheet, which actually consolidates into Ocado Group. So one of the really good things that -- what's happening with Ocado at the moment, given its strong performance, is that it is generating good cash, which means that they can use some of that cash to fund some of the ongoing investments in capacity, which means that it will have a less of a draw on cash for us in the short to medium term. On the -- on your question about investment-grade metrics. Yes, look, it's a really good question. It's really important, obviously important point for this call. So let me actually take a good bit of time to try and kind of explain the philosophy in relation to this. So I mean firstly, when we say investment-grade metrics, we are largely talking about rating agency-type metrics. So in terms of net-debt-to-EBITDA being the kind of sort of primary kind of key metric in that regard. So yes, that is what we are targeting. We are targeting investment-grade type metrics. So you're right in saying that. How we're thinking about that is it's not necessarily -- it's -- our model that we have in relation to the next few years is around -- I mean I'm going to say a very kind of claim way, a CFO claim way of saying it, which is, is getting back to basics and to a certain extent, in terms of profitability, performance of both our Food and our Clothing & Home business and then very judicious investment spend. I'm going to come back to that judicious investment spend in a second, but the outcome of that model is demonstrating or is recovering our profitability. I'm moderately reducing our actual headline debt number, but obviously, our net-debt-to-EBITDA increasing pretty significantly as a result. So that's the sort of the rough kind of model philosophy. In terms of judicious investment, how we're thinking about this, I think if you think of the places where we invest, we invest a lot of money in our stores, in our supply chain and in our technology spend. And if I kind of take each of those in turn, the way we think about our stores now is that we do believe there will be a certain level of base investment required for our stores. They haven't exactly received a huge amount of base investment over the number -- the last number of years, and we believe now is a time for us to actually properly start putting investment into the stores that we're -- we've got a kind of a term we use, which don't obviously use internally, but the stores that we love. And we're talking about a base investment. Beyond that, the way we're thinking about investments in our stores is a self-funding mechanism where we will seek to realize value from our freehold stores and leverage that value to help fund the rotation, both store closures and store relocations and renewals. So that's how we're thinking about that part of our investment. The second big piece is supply chain. I think -- I guess the good thing about supply chain is that there's very, very clear paybacks in our supply chain investments, both in Food and in Clothing & Home. So we think there's a lot to go after there, so in some ways, the prioritization is made easier for me in terms of payback and particularly in the Clothing & Home part, which will be all around supporting our further expansion of our online business. And then finally, in technology. I mean, as with most businesses now in the world, technology spend is less about core underlying systems and more about the middle layer and indeed, the interface, the user interface and data as well. So we believe that there's quite a good return on investment. It's not quite a good -- a strong return on investment plan for our technology, which is largely around agile investments to both support online, to support the development of our supply chains that I've just discussed and obviously to store kind of core infrastructure. So that's -- I know it's a long answer to your question, but I just have to just explain that I don't make that statement lightly in relation to the investment gain metrics.

No, that's very clear. If I might just ask 1 follow-up. Would you mind reminding us what proportion roughly of your store estate is owned, if you can share that?

Is owned. Yes. Just -- let me just get that answer for you, and I'll -- I mean, we've got-- I mean, as it happens, we've got -- let me get the answer for you. Maybe we'll go on to the next question. Yes.

Over to [ Lisa Eastbrook ] at Fidelity Management and Research.

Actually, it was on your store estate and follow-up on the previous question, but more on the lease side. And I think you said this morning that you've had some success in renegotiating leases downwards. How should we think about your -- both your lease expenses and your capitalized lease obligation going forward? Should we expect both of them to come down with some of the work you're doing? And any color you can give there would be really helpful.

Yes, surely. I mean it's a relatively complex sort of question to answer because, obviously, it's very kind of detailed in terms of how we're doing this. But let me just try and kind of give some sort of simple aspects of our approach. I mean, in our Simply Food stores, where we've got sort of no concern about space. In fact, if anything, actually, we are actively looking for new space in Simply Food. Where we see opportunity in these events, we will look to regear and extend that lease liability. So that's where you'll see an extension of our lease liabilities, and that's what we were talking to when we explained 11 regears in the period. In our full line stores, what we have is a very detailed store-by-store regional strategy, which projects out what we think is the space required on the basis of an assumed channel shift, right? So what that means is we kind of estimate how much Clothing & Home space we need in each region, for example, based on the kind of various different scenarios on their different channel shift scenarios, then we layer on top of that our lease liability picture. And we do have a number of leases that are coming -- that have lease events over the next 7 years. And where we've got the opportunity to take advantage of those lease events, we will, which will obviously mean that will there be a reduction of the lease obligation in that regard. So certainly, over 3-year plan, I mean, we are looking at a drop off in lease obligation, by the way, which also does help for the, obviously, investment-grade metrics. Because the net of all of that does look for drop in lease obligations as we go through that 7-year period. And just -- sorry, Lisa, I'll just to finish back to that question. I mean approximately 40% of our business is on -- of our store estate to go back -- sorry, back to your question, Chris. Approximately 40% of our store estate is on freehold or what we call long leaseholds. Sorry, Lisa -- so back to you, Lisa. Does that answer your question?

Yes. And can I have 1 kind of follow-up on that? In terms of the leases that you renegotiated about kind of a 34% kind of rent reduction in H1, to what extent is that representative of the rent reduction potential across even the Simply Food stores that you would like to keep or are doing well over the coming years? Or is there anything in particular about those that wouldn't be fair to extrapolate that as a potential rent saving for you?

Well, I mean, it is a good period at the moment to be doing lease regears, right, given where the world is from a property market. So I think it's fair to assume that -- I mean we are projecting that in our Simply Food stores, as we have lease expense, that we will have a reduction. Not quite at those levels, but still at kind of relatively decent and healthy levels. I mean it's not a material feature, I would say, in the overall cost-saving initiatives that we have for the next 3 years, but still important to go after.

We now go to the line of [ Isa Ali at Bearings ]. [Operator Instructions]

I have 3. One is quite just my technical understanding. In terms of the accounting for Ocado, the M&S product that's been sold through Ocado Retail, is that factored into the like-for-like growth? And is it -- are you able to exclude that so we know what went through that tunnel and what didn't? Is that a possible break that you could provide?

Yes, sure. I mean why don't we just deal with that now. I mean it's a very -- the way the delivery of M&S goods go to Ocado, largely most of it, I think most of it, [indiscernible] percentage. 95% of it currently goes directly from suppliers to Ocado Retail. So we never take control, and as a result, it never consolidates its revenue in our business. So a very small amount goes what we call indirectly, i.e. comes through M&S. And then M&S, it's consolidated, and then M&S supply to retail, and it was about 5% in September. And as you can imagine, September was only 1 month. It's relatively small. So square root is very little, actually, I think it's fair to say. And where our anticipation is we are going to reduce that indirect route even more. So it's not going to be a big feature.