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

Hello, everyone, and a warm welcome to the Marks & Spencer Full Year Results Fixed Income Investor Q&A. My name is Bethany, and I'll be your operator today. [Operator Instructions] I would now like to hand the floor over to Eoin Tonge. Please go ahead.

Thanks, Bethany. So I just want to say a few words about the results we published this morning, and maybe then we can open up into questions. So we think we published a strong set of results this morning. That '21/'22 was a good year. Good growth in both our businesses, core businesses. So 10% growth in Food, nearly 4% growth in Clothing & Home. And Food was driven very much by larger baskets across the year, with hospitality and franchise starting to compensate for the normalization of some of those bigger baskets in our fourth quarter. The online growth in Clothing & Home continued to be strong. And actually, we are particularly pleased with our full price performance in Clothing & Home, which delivered such a strong operating profit performance in the year. Ocado Retail had actually a good year. I'll talk a little bit more about that as when we come into the outlook. And probably pleasingly, which not just for this audience, but for every audience, the cash generation was particularly strong, GBP 700 million of free cash flow conversion, albeit there are some temporary items in there in working capital that I'll come and talk to. It was still a very, very strong performance and leaves our balance sheet in a good place as we enter into a more uncertain environment, which I will come and talk about. Overall, we think we're -- it's another important milestone in terms of our business transformation. Obviously, there is a leadership transformation happening today. And in fact, the baton, I think, has been passed in our town hall meeting straight after this. But Steve is leaving [indiscernible] having now we've seen a really strong market share growth in both Food and Clothing & Home through the pandemic, where the quality of value and style perceptions have improved in both of our businesses. And with the Ocado Retail setup for further growth, albeit against a more difficult backdrop, with a store rotation program that is in full flow, with a strong new renewal format in Food and more recently in Clothing & Home. With our Sparks data engine now at 15 million and our app users are 4 million. So we believe we're in good health, both strategically, operationally and financially and well set up for the next phase. And indeed, well set up for the year that's ahead. And in terms of the year ahead, we do expect the year to be a challenging year from a consumer perspective, particularly in our second half of the year. No kind of amazing insights for me to say that it is going to be a challenging year in the sense of it's going to be high inflation and a cost-of-living squeeze. And we think the business is set up pretty well for that environment. Our business is set up better from a value perception perspective and are -- in both businesses, and I can talk more to that, I'm sure, in the Q&A. Although, our customers are not immune to the pressures that are -- that's facing the marketplace, our customer sets tend to be -- have a better cushion of savings that they have generated through the pandemic. And actually, something that I think is kind of becoming more and more important is that we are seeing the benefits of our business diversification across Food, Clothing & Home and our International business. So what does all that mean? I mean, I think if you adjust our business for a -- for the fact that we're not going to have business rates that we had the benefit of in the first half of the last financial year. We've also exited Russia, which I can talk -- take more questions on. And we don't expect Ocado Retail to generate much contribution on the back of the guidance that Ocado Group gave today. When you put all that together, our starting base is about GBP 440 million of adjusted profit before tax. Even although we're in it, a decent shape. It is going to be challenging. So we're not expecting the business to progress on that number in the financial year that's coming. But we are in a good place. We're in a good place from a balance sheet perspective, and we are expecting to step up our investments in growth areas, in technology, in our supply chain and in our store estate. So I think I'll leave it at that. I think hopefully, that's a good enough intro. I'm sure there's plenty of areas that people want to explore further.

[Operator Instructions]. The first question comes from Rebecca Clements at Fidelity International.

On this morning's call, you talked a little bit in response to some working capital questions from the equity community. You did mention some supply chain financing agreements. And I did -- or at least I tried to do a search of your annual report last year, and I didn't see any reference to that, although I might have missed it. Have you disclosed what your supply chain financing facilities are in terms of size and how much utilization you've used on that?

Rebecca, it's James Rudolph here. We disclosed that within our payables note, I believe, in the annual report and accounts. So that should be visible when the report comes out shortly.

Okay. And did you report both sides of the facility and usage of facility? Or what did you report historically?

We report usage, from memory.

Usage, okay. I know there's been increased transparency around this or increased disclosure by a lot of your sort of peers as it's become something more relevant or more of a focus point, I think, from an accounting perspective. So do you plan on changing the amount of usage or facility going forward? Or do you think it will be consistent with what you've been experiencing in the last 2 years?

It'll be consistent with last 2 years.

Okay. All right. And then on the CapEx, I think you -- sorry?

No, apologies. You carry on.

In terms of CapEx, do I understand correctly that it's GBP 400 million per year kind of the go-forward amounts from a -- for modeling. Is that a good sort of base case to use?

I think it's a good base case, yes, Rebecca, I mean I think we've got plenty to go after, I think, in terms of investments. Well in the 3 areas that I always talk about in technology, supply chain and store estate. I think we've got -- I think you've got probably more choices in store estate as to sort of how fast and how hard you go. But I think that's a pretty good direction to travel.

Okay. That's helpful. And then in terms of your Clothing & Home inventory. I can't remember if you guys did any packaway at all because of like delayed receipts or things like that. Is that something that you did? And if so, when would you expect to flow that inventory into store?

Just say that again, Rebecaa, what do you -- what is the [indiscernible] less? I didn't quite catch it.

Maybe it's not a term you're familiar with. They refer to it as packaway. So in some cases, because of delayed receipts of inventory that's seasonal, rather than using outlets or selling down at a big discount, some retailers have chosen to pack that away and then bring it back out for the appropriate season. Have you done any of that?

No. We -- okay. Yes. No. Well, we did. We did during COVID because COVID, obviously, we went from, overnight, to all our stores closed. So we didn't have much of a choice than to put it in some in storage. But no, that's not something we do on a regular basis. And that's all been cleared too.

Okay. And you didn't do that with any of your receipts in the last year then?

No.

Okay. And then in terms of the timing on receipts, this is clearly an industry issue. It's not something that I'm specifically saying that you guys have a special issue with. But what kind of experience have you had on the Clothing & Home side with respect to timeliness of deliveries? And have you been taking receipt maybe a little bit earlier just to be on the safe side? Or how are you guys approaching that?

Yes. I mean, we've been pretty much seeing a 2-week delay out of China for a number of months now, actually. It was a bit more extreme than that actually at the -- I'm trying to think the back end of the year, early part of this year. And so we're -- yes, so we're -- I mean, we've just adjusted our time lines. I mean, I'm not quite sure I'd say we're getting it earlier as much as we've just adjusted our time line such that and we match the delays that we're seeing rather than anything else. So at the moment, that's working okay. We don't -- I don't think we're having particular problems at the moment, but we just have to adjust our time line.

Okay. And then on rating agency, I probably won't be the only person to ask you about this. But have you had discussions with rating agencies yet post these numbers? And if not, when do you expect to catch-up with them?

We have had, yes, we have with both Moody's and S&P.

Okay. Is that something on the -- in the diary here in the next, I guess, couple of weeks?

No, I actually said Rebecca, we have had, yes. Yes, we have.

Oh, you have had. Sorry.

We have had yes. And we would, by a matter, of course, spend a bit more detail. James will spend a bit more detailed time with them over the next day or so.

Okay. All right. And then just really quick on the Ocado JV, I went back, and I was checking my notes. This probably was disclosed somewhere. But I know that the structure of the original deal was that there was a -- there were earnouts that were paid out over, I think, the first 5 years. But I thought that there was sort of a time line that was an incentive for you guys to perhaps, if you choose to, buy out Ocado's stake and make that a wholly owned property. Is that something that was part of the contract that was disclosed?

Yes. Well, there's quite a lot of detail in what was disclosed back in 2019. On your first point, there is contingent payments. There's a set of 3 contingent payments, 2 of them were actually paid in the financial year just gone actually. So -- and they were relatively straightforward ones. The last one -- there's a another one of GBP 156 million and that's going to be paid in the financial year '24, '25, and that's around a specific target level of earnings in the financial year ending November 2023. So that's just the -- that's going to be the period. So I mean our expectation is that we're going to be paying. And that would be the end of the contingent payments and brings us up to GBP 750 million of a payment principal. In terms of the kind of rights, et cetera, and so on, there is a period post 5 years to 10 years where both parties can sell or buy the other half or work together on a different form of disposal. So -- but it still requires both parties to actually have to work together on it. So that's not to say you could do something earlier than that. So it's just a mechanism for how we would talk to each other post 5 years, which would be August 2024. The other thing actually an important thing to note actually in August '24 is that consolidation of the Ocado Retail numbers will likely switch from August 2024 from consolidating into Ocado Group to consolidate into M&S. So that's just another important point in terms of data.

Okay. So it was sort of a prescriptive thing that you guys -- as opposed to now where you're just reporting it as a JV line, you will be -- fully -- you've already pre-agreed that you will be fully consolidating that from August '24?

Correct. Yes. So -- and it's effectively, I mean, from an accounting perspective, the sliver of ownership will effectively -- or sliver of control, I should say, will switch to us, and that's prescribed. It will happen in the year between August '24 to August '25, but our current view will be it will probably happen in and around August '24.

Okay. All right. That's helpful to know. And the last question for me is just in terms of the competitive environment. There's been a lot of news out about what the food retailers are doing. I haven't seen quite as much in terms of discretionary, so like Clothing & Home. But how would you characterize the competitive environment? You sounded pretty comfortable with summer, but are you seeing an uptick in sort of promotional activity at all or markdowns by competition? And I guess, if you have a comment on Food, that's helpful, too, although there's loads of press on that. So it's sort of endless from that perspective.

Yes. I mean the competitive position in Clothing & Home has improved quite a bit for us in the last couple of years with the -- some capacity coming out of the marketplace. And you'll see that actually in our market share gains that we've had over the last couple of years actually. So as it happens, by the way, the #1 Clothing & Home operator in the U.K. Next has also had market share gains as well. So both of us have actually benefited from capacity coming out of the marketplace. At the moment, we're not seeing that getting overly competitive in terms of promotional activity. And both businesses are generating good full price sales. So now I think our planning assumption is that, that will be hard to maintain in the second half of the year because the conditions will just become more challenging. But we're certainly entering this period in Clothing & Home in a stronger place from a competitive perspective. As you say, Food is a bit more nuanced and a bit more complicated. There is obviously quite a bit of competition in the grocery, retail, although we have a quite specific position within that. But we -- a lot of our competitors have talked about investing in price, albeit there still has been quite a significant amount of inflation that's gone through the marketplace. And overall, it's quite inflationary impact, actually, the read from Kantar for the last 12 months -- sorry, to the last 12 weeks, with inflation of 5.7% in consumer pricing. And in fact, actually, in the last 4 weeks it's 7%. And that's across the marketplace. So I think what you're seeing is that actually, it's quite inflationary across the whole marketplace. But I do expect people still to fight a fight on price, and that fight will continue through the year.

[Operator Instructions] We have a question from Chris Roberts at BNP Paribas.

A couple of questions. Two of them are sort of clarification. So if I may. So on the PBT, you're saying that GBP 440 million is the base. So that's broadly speaking, the kind of number we should have in mind for year-end. I just wanted to make sure that I understood that. The second thing that I would be interested in knowing a little bit more about is -- and apologies if this is something you've addressed previously, there was some discussion this morning on the hedging benefits you have. I think specifically on freight costs, but could you perhaps illuminate where else you might have sort of hedging benefits in terms of managing costs? And then the very last question following on from Rebecca. And apologies if this is too direct. Like you've, in the past, said that you're keen to get back to investment-grade metrics. We can all take a view on what metrics means, but could you give us any color on what your ambitions are in terms of timing in that sense, please?

Sure. No problem. Okay. So on the base, yes, GBP 440 million is the base of -- I mean, it's easiest just to got to a number, but GBP 440 million is the base. That's adjusting [ 2020 ] rates for a reduction in the contribution from Ocado, and the loss of profit from Russia. And what I'm saying here is that it's -- at this point in time, it's unlikely that we'll progress off that number. So that's the base, yes. Hedging, well, I mean, there's sort of 3 areas where we hedge. Well, it depends on whether you call freight a hedge. It wasn't freight, actually, I talked about this morning, but why don't I just kind of -- sorry, it was actually. We spoke about both; we spoke about freight and FX. But let me deal with freight, FX and energy. So on freight, the way we hedge is we tend to buy a seasoned for freight, and that's effectively how we hedge. So we are locked out for our freight costs for the year with our freight supplier. On FX, we tend -- we have a rolling hedging program on FX. We're quite highly hedged for this financial year. So this is dollar sterling for this financial year. And we get a bit of a benefit year-on-year because we hedged last year at a rate of $1.30, whereas this year, it's probably going to be in and around all in for $1.35. So we do get a bit of a benefit for that. We expect that benefit to be -- it's unlikely the rest of the market has that benefit. So we'll have to see how that whole kind of translates into really true competitive pricing, but there's a little bit of benefit there for us. Obviously, as you look forward into next financial year, i.e. '23, '24 based on current FX rates. So there's a bit of a headwind coming our way there. Well, our way, everyone's way there because we tend to be the longer hedges out there, whereas the rest of the market tends to be shorter hedgers. And then the final thing is energy where we do, again, also hedge forward, but we've suspended that obviously, since the energy crisis is kicking off at the end of this year, but we are still about 65% hedged in gas, which is our kind of primary exposure power -- yes, sorry, power, which is -- power. So we are -- so -- and we'll manage that a little bit more month ahead at the moment. So that is a real exposure that we're facing. Indeed everyone is facing right now, but it's in the guidance that we gave.

We don't have any further questions, so I'll hand it back to Eoin for any concluding remarks. As I speak, we've got a couple of more coming through. The next one comes from Louise Parker. In fact, we have a follow-up from Chris at BNP.

Yes, sorry. Maybe it was by accident. But the question on your timing ambitions in terms of getting your balance sheet back to IG metrics? And then -- I'm sorry, if I could follow-up. What was the rationale for the tender for the -- sort of small tender for the bonds, just to understand the thinking around that, please?

Yes, sure. No problem. Sorry, Chris, completely forgot. I was so engrossed in the hedging answer that I forgot the investment-grade answer. So yes, look, I mean we -- I mean the timing is -- I'm going to try and get to investment-grade as soon as we possibly can. I don't want to be facetious on that, but that's -- we're working hard on that. But I think we have to balance that with the fact that the business does have investment needs. And -- so I mean it's that kind of balancing act, if you will, Chris, around doing that in kind of a sensible way. Obviously, we've had a great run on the balance sheet. Maybe I shouldn't use run on the balance sheet, it's probably the wrong expression. But we've had a great performance in the balance sheet over the last 2 years, certainly further beyond pretty much anyone's expectations where we were standing around the time of the pandemic when it started. But I still think we have more to do, and I'm sure the rating agencies will come out themselves, but they're going to want to see more of a track record. And obviously, we've got the macroeconomic environment, that's kind of we're faced as well as. It's going to take a bit more time, I think, to kind of work through that balance. Obviously, I've got demands on the other side from equity investors who wanted me to restore the dividend. You'll see on that, though, that we said that we're going to consider that at the end of the year. So we're not -- we haven't introduced a dividend, and we're still going to keep that under review. Because as I say, priority is to invest in the transformation and get the balance sheet in the place we want it to be, which is having an investment-grade metrics. It actually has exited the year with investment-grade metrics, but there's a little bit of area of caution there, which is, one is, I am expecting a step back in earnings for the forecast. I am expecting a reversion of some of the working capital of about GBP 100 million. We are going to start paying cash tax, which we've had the benefit of not doing over the last couple of -- period of time. And so if you take all that into account, it will -- we're not going to move forward on our investment-grade metrics -- I'm sorry, we're going to stepping up our capital investments. We're not going to move forward in our investment metrics in this financial year. So we might as just be kind of all be upfront about that. And -- but it's a big focus of mine. Sorry. And to your last question, I mean, did you want to take rationale for the bond?

Chris. So you'll have seen that we've got a very strong liquidity position, GBP 1.2 billion of cash on the balance sheet at the year-end. And this allows us to manage our upcoming maturities and to deliver some economic benefit, while still maintaining that really strong liquidity position. So it seemed a prudent and sensible step.

The next question comes from Louise Parker of Bloomberg Intelligence.

Just to say that Chris asked all my questions on capital allocation, and you answered them.

And now we have no further questions. So I'll hand it back to you, Eoin, for any concluding remarks.

Thanks, Bethany, and thanks, everyone, actually for participating in the call. As I say, I think we're making good progress. We're pretty well set up for what is going to be a challenging year in both parts of our business and also in our International business, which we didn't speak about. And I look forward to engaging with you through the year. Thank you.

This concludes the Marks & Spencer full year results fixed income investor Q&A. Thank you for joining. You may now disconnect.