MARKS AND SPENCER GR

MKS
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Transcript : Marks and Spencer Group plc, H1 2023 Fixed Income Call, Nov 09, 2022

09/11/2022 | 15:00

Presentation Operator Message
Operator (Operator)

Good afternoon, and welcome to Marks & Spencer 2022/2023 Half Year Results Fixed Income Investor Q&A. We will begin a Q&A shortly. But before this, I will hand over to Eoin Tonge, Group CFO and Chief Strategy Officer. Eoin, please go ahead.

Presenter Speech
Eoin Tonge (Executives)

Thank you, and good afternoon all. I just thought I'd say a couple of quick words. Sorry, some of you might have already listened in to our transcript earlier and the analyst conference call. But we think we had a good set of results published this morning for the first half. And Clothing & Home of 14%, up 5.6% with market share growth in both businesses. Actually, overall, we landed the half, broadly in line with our expectations, and with a bit of a different mix between Clothing & Home and Food profits.

Food profits were down and the margin was down at 2.2%, and that reflects really our decision to hold our shape in the transition to the high inflationary environment and improved as the half went on, but it also reflects the fact that we have the timing of cost growth across the year, which was a lot more significant in the first half than we expect it to be in the second half.

Clothing & Home traded very well, driven by the strong sales growth. And indeed, the profit performance reflects that. And the Ocado numbers are very much in line with the guidance of Ocado Day in September and the contribution that M&S get on from Ocado reflects some one-offs for that 6-month period.

And then the balance sheet ended up in good nick. There was a free cash outflow, obviously, you will have seen in the year -- or sorry, in the half, driven by obviously the acquisition of Gist, but also working capital outflow, albeit that we expected a working capital outflow, it was a little bit higher than we had planned for.

I think that's really kind of the main highlights. Obviously, we gave quite a bit of commentary in terms of how we're gearing up for FY '24, which is, obviously, very much top of mind, but I'm sure, I will take some questions in relation to that topic as we go through.

So over to the questions, I think.

Question and Answer Operator Message
Operator (Operator)

[Operator Instructions]

And we have our first question from Rebecca Clements from Fidelity International.

Question
Rebecca Clements (Analysts)

I've got a few questions. I did listen to your call this morning, but I'd just like to dig a little deeper into your inventory situation. Since you acknowledged it was a bit higher, I think, than you expected. Can you give us any color in terms of the sort of year-over-year increase? Maybe approximately how much is inflation-related versus early receipts and versus maybe slightly stale inventory?

Answer
Eoin Tonge (Executives)

Don't have much, slightly stale inventory. So you can kind of sort of maybe carve that off immediately, and we -- it's just -- let me think a little bit more on the inflation. I think it's about GBP 30 million, GBP 40 million relating to inflation and probably another GBP 30 million, GBP 40 million relating to kind of early receipts in last year, the inflation is a bit more spread across both Food and Clothing & Home, albeit it's weighted more to Clothing & Home, given that's where our big stock is.

Question
Rebecca Clements (Analysts)

Okay. Was there anything else contributing that I missed or didn't ask about that was also a factor?

Answer
Eoin Tonge (Executives)

No, not really. I mean, yes, there's a little bit of restocking that's happening more in our international business in India, and actually that we -- as you -- as India has kind of got back up and running, kind of post-COVID, that wouldn't have been a material impact. There's nothing else really untoward if you know -- I understand people are kind of concerns about stock levels, et cetera, and so on. But there's nothing particular untoward. I mean, the reality is that the -- actually flow of stock is happening, it's almost back to normal, actually. And it just means that we're flowing back a bit faster into our retails.

Question
Rebecca Clements (Analysts)

Okay. No, I completely appreciate that inflation is a big factor here. So it's just helpful to have a sense for how much of that is early receipts, inflation, et cetera, as opposed to kind of from a units basis. Would you say you're relatively stable on a stock unit basis?

Answer
Eoin Tonge (Executives)

Yes, pretty stable. Pretty stable. I mean, I think we're -- yes, it's not something that's particularly concerning us at the moment. And don't forget like 60-or-so percent of our stock is what we kind of call core flow. So effectively, it flows and has matched with, against us.

Question
Rebecca Clements (Analysts)

Okay. No, that's absolutely fine. In terms of the -- I think, I missed one of the last questions that you had this morning. But the remeasurement of contingent considerations for Ocado, so that was an income statement item. Should we think about almost like an impairment?

Answer
Eoin Tonge (Executives)

No, it's not an impairment. It is an income statement item that will ultimately turn into cash. So obviously, this relates to the contingent payments due to Ocado. It's the last effectively payments relating to the acquisition of the 50% interest. And this has got -- it's based off a measure of performance for the financial year FY '23, which is the end of November '23 for Ocado retail. And we -- from an accounting perspective, you have to revalue that contingent payment every balance sheet date. And that's what we've done this time around.

Obviously, there's a bit more uncertainty around the payments because of where we are, and indeed, where Ocado is trading. So we've had to put a range of probabilities against it. And as I said earlier in the call today, it's fairly early. We haven't even started that financial year. And so it's -- but that's incredibly weak, we have to do some sort of measurement against it, from an accounting perspective.

Question
Rebecca Clements (Analysts)

Okay. And is that -- so the earn-out or the contingent consideration, does that sit under long-term liabilities currently on the balance sheet?

Answer
Eoin Tonge (Executives)

It does, yes.

Question
Rebecca Clements (Analysts)

Okay. And is the expectation for Ocado to get back to sort of clearly positive EBITDA? Or is that maybe not a realistic expectation for at least this fiscal year using your calendar fiscal year?

Answer
Eoin Tonge (Executives)

Well, the guidance that they gave more recently was for EBITDA sort of flat for the financial year ending -- end of November this year. And we're still really in the budgeting process really for next year. And obviously, most people's budgeting is a little bit later, given some of the uncertainty and so on.

So there's -- as the guys said on the call earlier today, we're still pretty positive about the Ocado investment. Obviously, it's going through a bit trickier times with the reversion post-COVID and on the cost increase that everyone else has seen. But at the same time, we've got a lot of capacity. So we're effectively under-leveraged from a capacity perspective.

But all of that will work itself out. It's a question of probably the timing to which it works itself out. But there's a fair few movers to pull that -- we're working with management on pulling in relation to the financial year going. So it's not really my role to give guidance for next year, and it's a little bit too premature because we're still setting the budget.

Question
Rebecca Clements (Analysts)

Okay. And is it reasonable to think though that they're not going to be self-funding and that there might be some, I guess, investment on your end required?

Answer
Eoin Tonge (Executives)

Yes, I think it is reasonable to assume that. I think, I probably said that the last time actually. We've always sort of assumed that we're going to have to make some funding requirements into Ocado. But obviously, that's sort of becoming more realistic, given that the sort of return to profitability is taking a bit longer. So they're not really generating the cash to offset the cash requirements for CFC rollout.

Question
Rebecca Clements (Analysts)

Okay. And I guess that would be part of maybe for your budget for fiscal '24? That is something that would be included in there?

Answer
Eoin Tonge (Executives)

Correct.

Question
Rebecca Clements (Analysts)

Okay. All right. And then just 2 more for me and then I'll get back in the queue. Do you have any -- have you decided what you're going to do with the December 2023 bond maturity? You've obviously done a part tender here. Is it reasonable to think that you would use balance sheet cash to repay that? Or is that something that you'd maybe look to refi?

Answer
Eoin Tonge (Executives)

I mean, I think we sort of -- we keep on the advisement -- I think -- so did you ask the 2023, did you?

Question
Rebecca Clements (Analysts)

Yes, the December 2023.

Answer
Eoin Tonge (Executives)

Yes. I think we keep it under advise. We see a lot of moving parts in relation to liquidity positions at the moment. And I think if you'd asked a few weeks ago, people were kind of pushing for buybacks and things like that. And then the U.K. mini budget and everyone is kind of saying preserve liquidity. So there's quite a lot of moving parts at this point in time.

The business has got a healthy liquidity position. I think I've given my thoughts and my advice to the business to sort of expedite, and -- but it's -- and it's got a few options. Look, the '23 is probably -- we probably won't need to refinance. And I think it's fair to say, months too early for FY '25.

Question
Rebecca Clements (Analysts)

Okay. Yes, I know it's a bit early days for the '25, I agree. Last question is, and I'm putting it to you, of course, but how -- is there any update in terms of the search for your replacement?

Answer
Eoin Tonge (Executives)

Well, there isn't because, obviously, we would have been talking about that, earlier today. So it's -- obviously, I won't be able to say more than that. But I think -- I'm hopeful that there will be enhancements imminently in terms of that.

Question
Rebecca Clements (Analysts)

And what's your last date?

Answer
Eoin Tonge (Executives)

I'm going to be here until the end of the year.

Question
Rebecca Clements (Analysts)

End of calendar year?

Answer
Eoin Tonge (Executives)

Yes.

Question and Answer Operator Message
Operator (Operator)

[Operator Instructions]

We have any questions from Stephen Hade from CBAM.

Question
Unknown Analyst (Analysts)

I was just wondering, is the resumption of dividend payments still dependent on you having investment-grade credit metrics at the year-end? And presumably, do you think those investment grade credit metrics will stay into the full year 2024?

Answer
Eoin Tonge (Executives)

Yes, it's a very good question, Stephen. I mean, look, obviously, we probably have investment-grade metrics now where we probably -- we do have investment grade much now. But obviously, the world is an uncertain place. So it's kind of unlikely that we will get an upgrade, et cetera. And obviously, if we roll forward, I mean, we're not of the only ones talking about a relatively gloomy picture into 2024 and maybe even a little bit beyond.

I mean, actually, as it happens, I think, the M&S is pretty well set up into this period of challenge, but there are lots of headwinds. We all know that there are headwinds into next year. And so I think we have to -- I think there's kind of a number of things we have to wait and see before the year-end, which is like, for example, we have to do our budget. We have we have to make sure that we're very clear on the cost headwinds, but also on the cost or initiatives et cetera, and so on, and a bit of better sense for what kind of trading -- the trading environment looks like.

I think having visibility around investment grade metrics is a stated aim for the business. So that will always be a factor in when we make a decision around capital returns to shareholders. So that being said, obviously, the big thing that's going to impact investment grade metrics is what's your view on profitability is going to be for the next 24 months. And I think the business will absolutely take that into account when it comes to it. But its starting position is good in the sense that the balance sheet is in good nick, and that is obviously very, very strong.

So I know it's a long-winded question, but I don't think the business is going to deviate, at least, I don't think. So it's going to deviate from wanting visibility to investment grade metrics.

Question and Answer Operator Message
Operator (Operator)

Next, we have a question from Brandon Clark from Bernstein.

Question
Unknown Analyst (Analysts)

I just wanted to pick up on the question of wage inflation. I think you touched on it earlier on. But just elaborate on it a little bit, maybe. I think you said 7.4% as you increase this year. But presumably, you do have some visibility into next year on the basis of that, I mean a lot of competitors are out there with secondary increases already, I'm -- around this time of the year going into Christmas. So you should have an idea. And I would have thought it was even above the 5%, I think you mentioned on the call.

And maybe just elaborating on that theme. Just where -- is there a scope for efficiencies or savings if you do land another net sort of high single digit again? Is that something that could be offset in either pricing or efficiencies? What are your thoughts?

Answer
Eoin Tonge (Executives)

Yes. I mean, I think, look, well, just about being quite specific, we've already gone twice ourselves this year. So we started at 950 and ended at 1020 for our colleagues. So that was effectively 5% and 2%. So that was kind of what the all-in 7% is. So obviously, we have -- that second one came a little bit later in the year. So we will have a bit of rough effect for that into next year.

So it is genuinely hard to call exactly what the exact inflation is going to land into next year. I don't think it's going to be as high as 7%, but I think, again, it's a little bit of crystal ball goes in -- for me to do other than that. I think the -- it's probably more in the realm of 5, but we just don't know. And we'll see how we go on that.

Look, we've had now a program of retail efficiency going on for about 2 years, well, 2.5 years. I'm not just saying that because I'm CFO for 2.5 years, but I have been on for 2.5 years. It started with the big restructuring that we did in August 2020, and we've been running a kind of a series of micro projects.

And although they're not that small for the last 1.5 years or so, which we have a whole list still to go into next year, and this is all around kind of technology and the rollout of automated sales, et cetera, and so on. So we've got pretty good visibility for cost side next year on the retail specifically.

Question
Unknown Analyst (Analysts)

Yes. Okay. So a good deal of 5% could potentially be offset without recourse to the price, you think?

Answer
Eoin Tonge (Executives)

Yes, I think so. I think so. And that's the sort of kind of model we're thinking anyway.

Question and Answer Operator Message
Operator (Operator)

Next in queue we have Chris Roberts of BNP.

Question
Chris Roberts (Analysts)

A couple of things on my side. Can you remind me, please, what guidance you are giving in terms of where you think working capital ends for the year, whether the sort of -- just like if you want to call it disappointment in the first half will be offset by a sort of slightly better-than-expected second half. How should we think about the balance of the year on that front? That would be very helpful.

And then I have a follow-up question on this sort of idea of investment-grade metrics. Should we understand that getting back to investment grade on the rating side is a target, albeit, obviously, I understand that, that's not, in some respects, that you can't decide what the agencies do. But my point being that the ambition is on the rating as much as the metrics. Any thoughts on that would be very helpful.

Answer
Eoin Tonge (Executives)

Sure. Yes. Well, look, I think the -- I mean, we had -- I mean, just kind of very random numbers, obviously, working capital, you have to use a somewhat random number for a business of our size. But we have more of a budget of circa GBP 100 million of an outflow for the year. And so you can see, obviously, the first half aiming into that quite a bit -- sorry, overshot that quite a bit.

So I'd be hopeful it comes back closer to the budget, maybe a little bit above it because of the inflation that we talked about. The underlying kind of primary kind of driver of working capital outflow in the year is payment terms in our Clothing & Home business, but also some of that inflation that we've spoken about as well.

So I think that's -- my hope would be that it will come back a little bit as we finish the year. But there's no usual caveat around timing and phasing when it comes to working capital. But there's nothing else sort of material for our stockpile, I think, it's kind of normal flows, if you will.

On the rating, well, look, obviously, for a business that's outbound out there and the way it's financing, if you're going to talk about investment-grade metrics, we would prefer to have actually an investment-grade rating. And so I think we work hard and work very closely with the rating agencies to make sure that they are fully appraised and have understanding of the business and in the normal way. We put a lot of effort into that, and we continue to put a lot of effort into that because we're going to put a lot of effort in trying to get in and get investment-grade metrics. We're going to be -- we're going to want to join the rating to go with it.

I think the only reason why I think the distinction is important that sometimes you have to make decisions based on your position rather than waiting for a rating to come.

Question
Chris Roberts (Analysts)

Yes. No, those are very good answers. I appreciate the color.

Answer
Eoin Tonge (Executives)

Sorry just to finish off that question. This is a business that's always have an investment-grade rating at least for a long time. So it's sort of in the DNA.

Question and Answer Operator Message
Operator (Operator)

Next question is another one from Rebecca Clements at Fidelity International.

Question
Rebecca Clements (Analysts)

Just 2 follow-ups for me. The first one is in terms of the energy situation. I think that you said that potentially up to GBP 100 million extra cost next year. Are you hedged from an energy perspective for the remainder of this fiscal year? And how much have you hedged forward for fiscal '24?

Answer
Eoin Tonge (Executives)

Well, I mean, we're -- at this point in time, this fiscal year is becoming sort of less important because we're in November. There's only really 2 months -- that really 1 month -- 1.5 months of real serious energy exposure to go. So hedging less isn't sort of relevant anymore. We say this way, we've got fairly clear visibility as to what costs are going to be for the remainder of the year for energy. And obviously, there's a bit of a backstop with the government support as of today anyway.

The next year is obviously a bit trickier. We're left hedged into next year. We've got a small amount hedging. The risk premium on winter next year has just been so high for so long. It's come down quite a bit actually in the last couple of months. And just been so long that we just didn't feel it was necessary anyway.

Question
Rebecca Clements (Analysts)

Okay. So I guess, in a normal year, what has been the policy in terms of hedging forward for energy?

Answer
Eoin Tonge (Executives)

Well normally, I mean, we've got a rolling hedging period. We seek to be, for every period, 50% going into the period. Yes. Yes. So no, yes, normally, we probably -- we would be back probably about half hedged for next year now. So yes.

Question
Rebecca Clements (Analysts)

Okay. And then last question. Just in terms of supply chain financing, reverse factoring. Are you at this -- are you at similar levels of usage? Or has that increased since your fiscal year-end report?

Answer
Eoin Tonge (Executives)

Yes, it's come down slightly. As you can imagine, actually, a reduction of payment terms with the Clothing & Home, we've had less of a demand on us. So we're always looking to try and kind of optimize that in such a way that it doesn't become kind of an overreliance, if you know what I mean.

Question
Rebecca Clements (Analysts)

No, as kind of investors, we wouldn't want you to over-rely on that either.

Question and Answer Operator Message
Operator (Operator)

We have no further questions. So I'll hand back to Eoin for any closing remarks.

Answer
Eoin Tonge (Executives)

No closing remarks really other than thank you very much. And hopefully -- and as we sort of enter probably a bit more shopping order. And I probably sign off and thank you for the calls over the last couple of years or so.

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