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

Good afternoon, and welcome to the Marks & Spencer's 2022/2023 Full Year Fixed Income Investor Call. [Operator Instructions] I'll now hand the call over to your host today, Mr. Sandeep Dasgupta, for any opening remarks before we begin the Q&A. Sandeep, please go ahead.

Thank you, and good afternoon, everyone. In the room, we've got a mixture of a lot of M&S finance colleagues across Treasury and Finance. Before we start the Q&A, I'm going to hand over to Jeremy Townsend, our CFO, for a few words.

Thank you very much, Sandeep, and good afternoon, everybody, and thanks for joining the call. Hopefully, you've got a chance to see our results this morning. We published an RNS at 7:00, and there are presentations on the website from Stuart, Katie and myself covering the results. So if you haven't had a chance to see those, please take the opportunity to have a look at those, where we go through the results in a bit of detail. But for the purpose of the call, I'll just give a quick 2- to 3-minute introduction just highlighting how we finished '22/'23 and some points in relation to the current year. So you'll have seen from the results, we had a better-than-expected outturn, better than we anticipated at the interims and the Q3, and that's being delivered by a number of factors. We're a bit pessimistic at Christmas around where the U.K. consumer would be. But in actual fact, both our Food and our Clothing & Home offers have stood up well, and we've continued to maintain sales momentum in both of those areas. International growth rates has also been good. We have continued to experience cost wins, but those cost wins have been slightly lower than expected, with energy costs coming down, and that reduction in energy cost inflation, although it will be a headwind in '23/'24 is less than previously expected. And then we have also helped ourselves by taking actions to drive out costs as part of our cost-out program and the benefits of the Gist acquisition into our supply chain has also helped second half operating margins and mitigated cost inflation. We had a strong performance in cash and working capital in the year, with free cash flow from operations, helping to reduce net debt and also reducing interest costs relative to expectations. So we're very pleased with the results and the momentum and the shape in which we deliver the numbers with effectively our decision to invest in gross margin in both businesses. While it impacted gross margins, helped drive sales and market share, and actually, we were able to offset a lot of that investment through cost savings. As we go into '23/'24, as you may have seen in the announcement, we've had a good start to the year, both businesses are in sales growth. Food, we like events in Marks & Spencer's and we had a good Easter and also the coronation was very useful. In Clothing & Home, although the weather has been a bit unseasonably chilly, we're pleased with the way Clothing has performed, and both businesses have been in growth at least in the start of the year. Some uncertainty remains in the outlook, but we're doing everything we can within M&S to mitigate that. And as part of this, we expect modest sales growth in the year, but we will be continuing to invest in gross margin in both Food and Clothing & Home with cost of goods inflation expected to run ahead of our price increases, and particularly in Clothing & Home, where we've got some FX issues as well, that will be affecting gross margins. We'll be offsetting this in Food through looking to target waste loss. Waste loss was particularly weak in quarter 1 of '22/'23, and we'd expect some improvement in there. Also within operating margins, we get the full year impact of the Gist acquisition, which was bought at the beginning of H2. We're expecting -- I've already mentioned the headwinds we're expecting in energy of around about GBP 50 million. We've also got colleague pay increases as well, but we are increasingly confident about our structural cost program, which, as I've said, helped us in Q4 of '22/'23, and we're anticipating about GBP 150 million further savings from that in '23/'24. After you've taken into account some investments in customer service and continued investment in our digital technology, we're expecting an overall increase in -- a small increase in operating costs, but we're looking to offset that through sales increases. At a more specific level, we're expecting a good year from international, although probably more modest growth given that the international business benefited in '22/'23 from coming out of the COVID period and some restocking from our franchise partners. In Ocado, Ocado made an underlying loss of about GBP 25 million in the second half. If you extrapolate that into '23/'24, there'll be a slight improvement, we think, on that run rate. But overall, because H1 had some exceptionals in it, we'd expect a loss slightly bigger than 2x 25 -- it's slightly less than 2x 25, but in that order of magnitude. So overall, in terms of '23/'24, we're expecting to continue to make good progress. There will be headwinds of costs, but we're hoping to largely offset those through sales. And the market at the moment is looking for us to be broadly in line with '22/'23 or if not, just slightly behind. You'll also see if you read through the statement, we focus quite a lot on our capital allocation. As part of that, we committed to looking for an investment-grade credit rating, looking to achieve that if we can within '23/'24. Obviously, that depends on the rating agencies. We're -- we think we're at investment-grade credit metrics. But clearly, we need to establish a track record in terms of doing that, but part of the journey towards that is making a commitment to that internally and externally and looking to make sure that we manage the financial framework of the business accordingly. Within that framework, we've talked a bit more in this announcement about how we've allocated capital and how we're planning to allocate capital; the criteria and hurdle rates we'll use for capital investments; and how we look to manage investment in our stores, supply chain and digital; and also how we're looking to focus on free cash flow to help fund that investment. We've also said as part of that capital allocation framework that we are looking to restore dividends at the half year, albeit at a relatively modest level with what we think is a good balanced approach to our stakeholders, customers, colleagues, shareholders and bondholders as well as our pensioners. So I'm obviously more than happy to go into that in a bit more detail. But we felt going forward, it would be quite useful to settle that out, particularly as we're going into discussions on what an investment credit grade rating would look like and some premises around it. So that's all I was planning to say, Sandeep. More than happy to take any questions that anybody has got either around the year just ended or the year ahead.

Thanks, Jeremy. So it looks like we've got one question from Rebecca. [Operator Instructions] So if we can start with Rebecca, first, please. Rebecca Clements from Fidelity.

Okay. Great. So as you probably expected, just on the rating agency discussions, I mean, have you recently met with them? And have they given you an indication about how much of this is within your control, i.e., you clearly think you have investment-grade metric currently. And how much of it is sort of going to be related to the overall market? I mean clearly, the consumer remains challenged in the U.K., and I know that, that does factor into the rating agencies' decisions from time to time. So if you could elaborate on any discussions you've had with respect to that.

Yes. So Rebecca, thanks for the question. That's very much appreciated. So I've only been here 5 months, and I haven't had the pleasure yet of meeting the guys at Moody's and Standard & Poor's. I have had a bit of raised eyebrows from certain elements of my team going out and making a commitment without having had those conversations. And you're absolutely right. Some of this is within our control, and some of it is without it. So while I'm committed to getting the rating, obviously, I can't commit to what time frame that will look like, and I clearly don't want to speak for Standard & Poor's and Moody's until we've met them. But we are due to meet them in the next couple of weeks, and I'll be able to give you more information around that at the half year or earlier, depending on how well those conversations go. And the commitment really is about us meeting almost at the Board level, making sure that we meet those parameters and we come to meet it. But clearly, if the rating agencies have concerns about the consumer or about competitors, food retail or inflation or whatever it is, we'll have to hear those concerns and think about how we can mitigate those or appease those concerns in that journey. So there's no guarantee, but I think making a firm commitment is a start of that journey.

Okay. And along those lines, I appreciate that, as you said, you haven't actually met with them yet yourself, but you do have some of your treasury team members there, who I assume would have attended some of the previous meetings. Even if you're at those sort of metrics right now, I think one thing that sort of looms a bit for me and certainly would be a consideration for the agencies is the Ocado -- potential Ocado buyout. You obviously have the option for that in the kind of next couple of years, and that wouldn't be maybe the same prices historically, but also wouldn't be a small chunk of change. Do you think that, that would factor into their decision? Or do you have any commentary on that with respect to how you take that into consideration with your target to achieve investment-grade rating?

So that's a great question. Can I pick up the Ocado piece, and I'll just hand over to James to give any feedback he wants to on the more broader dialogue. At the moment, our relationship with Ocado is going very well. Our key focus is on improving the underlying trading position and working much closer together between the 2 businesses to improve performance. I don't want to say never, but we're certainly not having any conversations around the remainder of the piece. I don't think it's an option to buy the 50%. I think there's clearly down the road, that may or may not happen. But for the moment, that really isn't in our time frame. And we would obviously take that whole piece into mind in terms of our investment-grade commitments. So any cash outflows that hypothetically could be associated with that, that would be borne in mind. But it's not an immediate issue or aspect that we're contemplating. James, do you want to say anything further?

Yes. I don't think -- Rebecca, well, there is an option for us to [indiscernible] from August '25 -- '24 to '25 -- August '25. That's not a corporate transaction. It's not us taking control in a kind of like 100% equity way or anything like that. So in many ways, it shouldn't impact our credit metrics. So it will obviously impact the way that Ocado's results appear in our accounts. Generally, the relationship with the investment agency or rating agencies is very strong at the moment. We've got a very positive dialogue. And you'll have seen from the notes that they put out that our rating will be a combination of our strength of our business within the U.K. market and also our financial position. And I think kind of the good thing about the results this time is they demonstrate improvements in both of those aspects. So I think the agencies who want to know that, that is a continual improvement, but it's a very good position to be starting from.

Yes. I think you've done a good job in terms of the metrics, it's to say they can be -- especially when it comes to upgrades from high yield into investment grade or vice versa, they tend to be a little bit slower sometimes to make those moves and reluctant to do it if they think there's a chance that there would be a downgrade again in the future. So fair enough. Just a couple of sort of housekeeping things. The GBP 30 million related party loans to Ocado. So that -- from an Ocado perspective, that sits at the JV as a loan, and is that considered as fully drawn?

That's right. That is the cash that's been drawn down by the JV that's funded. That's our share of the funding and then GBP 30 million will have been funded by Ocado as well.

Okay. So both parties. So it's GBP 60 million in total then at Ocado.

GBP 60 million in Ocado Retail will have gone in, in the year, of which GBP 30 million was us and GBP 30 million was from Ocado, that the holding -- that the other 50% owner.

Okay. And do you receive -- do you actually receive cash interest on that? Or is it a pay-in-kind? Or how does that work?

We actually receive cash interest on that.

Okay. Okay. And then this morning, you were asked about working capital. I heard that comment on the call. It seems like it was mostly related to you will eventually get to kind of 75 days on your accounts payable in Clothing & Home, but you weren't there just yet. And you also made a reference to phasing. What portion of the sort of difference in working capital versus expectation was phasing?

Yes. So at the half year, we guided to GBP 100 million outflow. And the performance by the year-end was stronger than that, of which that -- so I think we were GBP 10 million outside rather than GBP 100 million. Of that, I've said GBP 50 million of that was phasing and that's our estimated outflow for the year. The -- just the caveat I'd raise is on working capital, we are looking to move to 75 days with Clothing & Home, and that's within our plan. If the business trades relatively well, we tend to get the working capital inflow. So working capital in Food tends to be negative. So there are a number of moving parts, but everything else being equal, I'm assuming a GBP 50 million outflow in the current year due to the fact that we had -- we were basically GBP 90 million ahead of where we expected at the end of '22/'23.

Okay. So that was my other question is that for fiscal '24, you do expect an outflow for working capital?

Yes, and that it should normalize after that. It should normalize after that thing.

Okay. And apologies, have you given CapEx guidance?

Yes, we have. So we're expecting CapEx -- so CapEx, if we ignore the Gist acquisition, CapEx in '22/'23 was just over GBP 400 million, and we're expecting the same amount in the current year.

Okay. All right. That's helpful. And then just a couple more things. Do you have any guidance on exceptionals for fiscal '24?

Well, they are exceptional by nature. So I'm not sure we've guided to that. We could dig around and give you some more insight. I'll speak to the guys and see if there's anything -- any more insight we can give you, Rebecca, around known knowns.

Yes, I think the things that you could definitely point to at this point in time is we would, of course, have some cash exceptional related to our store of state program which is sort of normal course most years, and it's probably not going to be that dissimilar to the number in cash terms to the one that we booked in the year just gone.

Yes. Yes. That might be the best -- yes, sorry, go ahead.

For your cost savings program, have you already taken all those costs already to the P&L? Or will those -- will you have some more related to that in '24?

So the cost savings we delivered in '22/'23, we're planning on another -- a further GBP 150 million of cost savings in '23/'24, which were incremental.