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

Good day and welcome to the Marks and Spencer's Half Year Results Fixed Income Investor Call -- Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Eoin Tonge. Please go ahead.

Okay. Thank you, and good afternoon to everyone. I just thought to make a few opening remarks, actually quite a short intro, and then we can hand over to questions. By now, most of you have probably seen our results, so I won't go through them in detail. But hopefully, you'll see that we've produced a strong set of first half results this morning, demonstrating really good strong growth in our core food categories and, in particular, in full price in Clothing & Home sales. And we're obviously particularly pleased that we've had continued online growth in Clothing & Home, which has offset the store decline that we've continued to see in a post-Brexit world -- post-COVID world, I should say. The results overall include business rates relief. So that just needs to be noted, particularly now that, that rates relief has tapered down post June. But overall, it has driven a strong cash flow generation and indeed a strong net debt reduction. We've talked about the results in 2 ways, really. We benefited from a good bounce back in a post COVID. But also it's demonstrating good underlying progress on our transformation. And that's seen in the market share delivery that we've had across all parts of our business in truth. It's seen in terms of our full price performance in Clothing & Home, which we believe is partly a result of a stronger value style and quality perception. And overall, as I said before, our online activity and our online presence is growing and strengthening. Our International business had a -- I guess a resolute result in the context of a lot more challenges, both COVID and Brexit related. And you've seen also this morning that we've given updated guidance for the full year. Obviously, this reflects the strong trading performance in the first half, but also to date right up until the end of October. And now -- and we are -- obviously, the numbers that we are quoting are ahead of previous expectations. And our central case is to deliver a PBT in the region of GBP 500 million with a CapEx of GBP 250 million, which will mean a larger reduction in net debt than previously anticipated. We obviously flagged that the environment is tough. It is a tough environment out there in terms of supply chain disruption, labor costs, et cetera. And we do expect that environment to continue to be tough as we go into next year. So hopefully, that's helpful as a intro, and me and the team are more than happy to take any questions that you may have. Back to you for questions.

[Operator Instructions] And we'll move on to our first question from Rebecca Clements of Fidelity International.

I have a few questions, if that's all right. The first one, just -- did you have any sort of -- I know you were asked about dividends on the call this morning, and you said that you were focused on your balance sheet and wanted to get back to a sort of normalized level, which this year is obviously still not a normal year. But did you have any additional commentary around that? Or how we as debt investors should be thinking about how you're approaching dividend policy in the future?

Yes. No, I mean, I think I've been pretty consistent to say that we are focusing our capital allocation on 2 areas, which is one is the transformation, and then two is the -- strengthening the balance sheet. And there's no doubt about it. The results and the cash flow we've had over the last 12 months really have been very encouraging from a balance sheet perspective. But we still got plenty to do. And I think from that perspective, I think it is -- as I've been clear on my call this morning, I think it's unlikely we'll reinstate dividend this year. I mean, obviously, people are now starting to question, well, does that mean we can -- look like a dividend for next year? I think it's probably a little bit too early for me to come back with that point of view right at this point -- right now. I think let's see how we are at the end of the financial year. But the priority still remains the same, Rebecca, which is we've got to have enough capacity to invest in the transformation, and we've got to strengthen the balance sheet. And in both cases, we've still got more to do.

Okay. And could you confirm, I think you said that sort of there'll be some catch-up CapEx next year since you didn't spend as much this year as you probably normally would have. But was that GBP 400 million?

Yes. I mean, I think it will be over GBP 400 million, at least that's what I'll be targeting because we have a number of things we have to get on and invest in, in our store estate, in our technology plans and in our supply chains. And we -- we're a little bit behind actually in the spend, which is reasons why the number, we don't expect it to be as high in this financial year, and some of that will flow into next year as a result. I expect it to be about GBP 400 million.

Okay. All right. And then the plan for the [indiscernible] -- you have GBP 163 million left on the 2021. Are you planning to pay that down with cash?

Yes, that's correct. Yes. I mean, obviously, we prefunded [ that ] with the issuance that we did last November. So -- but we're obviously in a most kind of healthy liquidity perspective than we were even then, and we're in a position to repay that fully in cash.

Okay. And then when you're thinking about your balance sheet policy and obviously targeting IG metrics, are you going to continue to look at things from a net debt perspective? Or would you consider actually reducing gross debt?

Well, we do look at both. We do look at both. And we also have the revolving credit facility that helps to support us with liquidity as well. So we do look at both. I think -- I mean it's probably fair to say the strong region -- it's almost got a somewhat easier metric to look at is net debt because it kind of links to your operational effectiveness. But I think -- but gross debt does feature into our policy in terms of making sure that we get back to IV.

IG.

Would you consider -- yes, sorry, investment-grade. Would you consider gross debt reduction, though? Because I mean, obviously, with working capital and things like that, and if you did down the road, I guess, institute a dividend policy, I mean, cash balances can move around quite a bit, right? So whereas gross debt doesn't tend to change. So it's a metric -- I mean, for conservatism, I typically look at gross leverage, but I know the agencies will look at net as well. But is that something you would consider?

I think it comes down to our overall capital and funding requirements across the piece and whether we can foresee that we've got structurally long-term excess cash position. In that case, buying back long-term debt may make sense. But in the short term, I wouldn't necessarily, yes, say we're making that decision yet.

Okay. And then just a few operational questions, and then I'll move on and let someone else ask question. You said this morning that from a stock perspective, that seasonally -- or Steve said, I think, that seasonally you were okay from an inventory perspective. But how do your seasonal inventory levels currently sort of compare from sort of 2019 levels?

They're lower, but that's because we've actually lowered stock in totality. I'd have to look at seasonal. We might see if we can get the answer to that question now. But we -- I just -- because, overall, the answer is that the stock levels are lower, but we -- I just see if I can dig out the seasonal point. So yes, I'll come back to you in that.

Okay. And then I think you also said you brought forward some spring/summer inventory or accelerated some of your purchases, which I can understand given the supply chain environment. Would you normally have any spring/summer inventory in stock currently? Or would that happen more kind of in the sort of December, January, February time frame?

No. That normally happens in December, January. And we haven't really -- I mean when Steve's saying we're bringing it forward, we're actually focusing on it much fast -- earlier. So I think we're -- because we know there are going to be delays, so we've brought forward, but probably with the aim that we're going to expect to receive it around the same time.

Okay. All right. And then last one for me and I'll get back in the queue. Do you have any working capital guidance for the year? Because, obviously, it was a benefit to cash here in the first half. But how should we think about it from a full year perspective?

Yes. I think the benefit in the first half will maintain for the second half, i.e., we're not going to get an unwind. I mean there are -- inevitably with working capital, it's hard to forecast because there's obviously timing that can impact it. But just directionally, I expect the first half performance to maintain into the second half. And I do -- but I do expect some of that to unwind into next year because we're getting the benefit of -- actually because we're taking in some of the stock a little bit later than we would have previously, we're benefiting from the fact that we've got payables that took us over the full year-end, and some of that's going to unwind into next year.

[Operator Instructions] We'll move on to our next question from Louise Parker of Bloomberg Intelligence.

Rebecca hit on most of my questions. I just want to follow up on whether you have a target for net debt to EBITDA in order to try to get back to investment-grade credit ratings. That's my first question.

Yes. Well, below 3, Louise, is the target, yes. Yes. But I guess it's probably fair to say sustainably below 3.

Okay. And just sort of getting on to the supply disruption and cost inflation we're seeing in the market broadly. Can you just comment on whether that's having a -- firstly, the supply disruption, if that's affecting your stock, certainly, in Clothing & Home ahead of the Christmas holiday season -- selling season? And with cost inflation, are you already seeing that being passed on to consumers in higher prices?

Yes. I think on the stock, I mean, like there's no getting away from the fact that it is a bit tough out there, right? And most people have been documented to say that they are having some forms of supply chain disruptions, which are coming from a whole different source of challenge, predominantly labor actually and labor challenges globally, but probably more -- slightly more acutely in the U.K. So if I take supply chain disruption in clothing, I mean, I guess we've been dealing with this problem for about 5 months. It sort of has moderated a bit, but not -- but the problem about it is -- what's happened is that it's a cumulative effect of lots of little issues, right? So it might start in a factory in Bangladesh that's shut down for a week because of a COVID restriction, that then gets accumulated by a tanker setting off 2 days later because the tanker wasn't available or just slow port movements or refueling, adding another 3 days into it because, again, the port has more restrictions or slower movement of tankers. So -- or container. So all of that is -- all that has added up to probably about a 2-week type of delay. And we've been just working that for the last few months, really. So prioritizing seasonal start back, to Rebecca's question, and flow merchandise because, obviously, flow merchandise, you can just maintain and you can just run it. So at this point in time, we don't think that there's going to be a challenge for -- an issue for availability in a peak -- or at least not material availability issues, like there will be -- I'm sure there will be patches of it but not material. But we've had to work hard to kind of get to that point of view. On the Food side of things, I would say the supply chains are also creeping. The labor availability in the U.K., in particular, is tough, as I said, and that is impacting our suppliers. To a certain extent, it's impacting our warehouses as well. And again, we're working through it because, obviously, we wouldn't have been able to maintain the high level of sales that we have if we weren't, but it's tough going. And I don't think it's without risk going into the Christmas period. It will certainly be hard work anyway to deliver. In terms of inflation, we haven't really seen material inflation come through in Clothing & Home, yes, but that's to do with long lead times and so on. But I do expect that to flow more into next financial year. So from that perspective, we haven't seen kind of prices moving yet. And I think in Food, we have been seeing inflation come through the system. And you'll see that the market is kind of moving prices by about 2% in totality. We moved them about 1%, which I wouldn't read acutely into actually to answer you. But other than -- I think you are starting to see flow-through into higher consumer prices. I think that will be a feature for the next 12 to 18 months.

We'll move on to our next question from [ Jerry Malek of PIMCO ].

I just wanted to confirm the CapEx guidance. So year-to-date, it's, I think, about GBP 250 million. Is it GBP 400 million for this year or next year, which you mentioned earlier on the call?

Next financial year. So I was really just talking about kind of response to the sort of what I expect we'd have to catch up into next financial year. And what I said in May is that I expected our CapEx to return to pre-pandemic levels, which is kind of GBP 350 million. And I'd say both pre-pandemic levels, which is GBP 350 million or so. And I -- but I'd expect that to be a little bit higher next year because I'd expect it to be a bit of a catch-up. So I'm -- just to be crystal clear, I'm talking about FY '22, '23.

Yes. So for this FY '21, '22 year, safe to say like CapEx would be GBP 250 million. Okay. Okay. So that was probably my mistake. I thought GBP 250 million was year-to-date, GBP 250 million, I guess, that's full year guidance then.

Yes.

The second question that I had was on -- which was touched on earlier as well, on interaction with rating agencies. I suppose, the leverage number that you're targeting, the net leverage of under 3x, and the key word there is sustainably staying at that level in your interaction with the rating agencies. What's your read of the situation? If you can show 12 months of net leverage being less than 3x, do you think that's sufficient to get to IG?

Yes. To be honest with you, you're probably going to have to ask them. But my -- I guess my experience is that it's probably at least 12 months and sometimes even longer. So it always -- with these things, it takes -- it's easy to get -- easier to get de-raises than reraises. But yes, I think that's right. I think -- look, that's kind of the decision for them. But we work very closely with them, obviously. And -- but I'm still on the journey because I'm not there yet. And we've got to work hard still to get there. And that's the reason why we're prioritizing the balance sheet the way we are.

We'll move on to our next question from Rebecca Clements of Fidelity International.

Just 3 more for me. The first one is, can you give us a sense of how much agency labor you use in your supply chain versus full time employees?

Well, we don't use a hell of a lot of agency labor ourselves, actually, but our suppliers do. And it does differ quite significantly by supplier because a lot of suppliers have to flex up agency -- sorry, flex up for variable periods. If I was going to estimate, my guess is about 20%, but it's a very rough view, and I'm not sure anyone has that number particularly to hand. So -- but that's more...

Has it been higher during holiday period?

Well, it's -- I mean, yes, but during holiday periods, it would be higher, yes, it will be higher and probably flex into something like 30% or so. But I don't know 100%. 20% is right for peak, is it?

Yes. Yes.

Okay. So about 20% for peak is right.

Okay. All right. And then how far in advance do you typically -- from a policy perspective, how far in advance do you typically hedge, say, your dollar exposure for purchases?

Up to 18 months or so ahead would be our standard policy. I mean we try and...

I mean, effectively, we try and hedge it out kind of to a certain extent as far as what we believe is liquid.

Okay. And then last question, this is a bit of an accounting sort of nitpick. But you referenced the write-back impact from inventory. So I assume that you wrote down inventories conservatively, and then some of that came back because things turned out to be better than expected. Did any of that actually flow through to your reported -- well, to the extent that you report gross margin, you talked about, particularly in Clothing & Home, which is where I assume this write-back happens. I think you said you had 90 basis points of impact -- positive impact to gross margin. Was this part of that? Or is this included in adjustment?

No, no. It is including adjusting actually. So this was in relation to the provision we made in May -- or March, I guess, '19, '20 -- March 2020 and -- to do with COVID, which was pretty conservative at the time. And you will remember, we released a significant proportion of the provision at the end of last year, last financial year, and this is kind of releasing the remaining part of this provision. There are some amounts utilized in the period, again, but for obsolete stock that was -- basically be carried from the COVID period. So -- but kind of simple terms, Rebecca, it didn't impact the underlying trading.

Okay. So none of these reversals on this have come back through in sort of your adjusted reported operating growth.

Correct. Correct. Correct. Yes.

[Operator Instructions] And it appears there are no further questions in the queue. I'd like to turn the conference back for any additional remarks.

Thanks very much, and thanks, everyone, and thanks for the questions. It's always good to get the questions, and they are slightly different, obviously. But hopefully, you'll see we're making progress, and we'll continue to engage with you in the coming reporting period. Thanks very much.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.