So is Marks & Spencer right to take a short-term profit hit in order to build the foundations for a turnaround in the long term?
The City was slightly shocked this morning to hear from the new management team at M&S that the gentle advance expected in underlying pre-tax profits in 2016/17 to about £725m is not going to materialise, with forecasts being guided down to little more than £625m.
Adjusted profits of £684m in the 2015/16 year (excluding the 53rd week) were only 4% up, despite the huge growth engineered in the clothing gross margin, so it’s not as if M&S have much to beat.
And the bulls in the City were hoping that all the heavy investment in modern IT, distribution and back-office systems incurred by the previous regime at M&S was going to start to pay off now, notwithstanding M&S’s distinctly lacklustre profit record.
Of course, it’s easy to blame “the economy”, just as it is easy for fashion retailers to blame “the weather”, for poor trading, but there is clearly something amiss with the UK consumer. And M&S are right (like Next) to point to the likelihood that the challenging trading conditions in the sector in recent months may persist (even if all the upheaval of Brexit can be avoided).
A flat clothing market will therefore make it hard to grow top-line sales at M&S, but what is harder for the City to accept is that M&S will continue to lose market share, despite all the work done on improving the product range etc, and that it is reconciled to seeing the same sort of miserable -3% like-for-like sales in clothing/home this year as it did last year.
Hope springs eternal that the new autumn/winter range will sell well and the new merchandising approach of the new clothing management team shows promise, but M&S will lose some business through its deliberate attempt to cut back on promotional discounting.
Brands that destroy their pricing power by constant discounting tend not to survive, as we’ve seen with BHS and as we nearly saw at Debenhams, so it must be right that new CEO Steve Rowe wants to focus (like Next) on selling more products at full price.
“Overall, much of what Steve Rowe announced today was sensible and prudent, but the City is cynical about the idea that the fall in profits this year is just a step back in order to go one or two steps forward in the future”
Cutting back on promotional activity in clothing will tend to help gross margins, other things being equal, but unfortunately M&S will have to absorb the cost of cutting opening price points to stay competitive, at the same time as the big gains from moving to direct sourcing start to dry up and M&S face FX headwinds on overseas buying.
And to complete the litany of adverse P&L issues, on top of weaker than expected sales and gross margins, M&S also have to face the fact that cost-cutting in the past has gone too far and that staffing levels in the stores need to be rebuilt (albeit, even with higher depreciation charges and new store costs, M&S still hope to contain total UK operating cost growth to 3.5% this year).
And the core UK business isn’t alone in having a difficult trading outlook as the much-vaunted international operation is also having a tough time, with underlying profits 40% down on last year and a raft of below-the-line overseas write-offs and restructuring costs also catching the eye.
Overall, much of what Steve Rowe announced today was sensible and prudent, but the City is cynical about the idea that the fall in profits this year is just a step back in order to go one or two steps forward in the future.
Reliance on food
After all, the plan is based on the assumption that nothing goes wrong with the strong side of the UK business, ie the food operation, even though like-for-like sales growth has already ground to a halt and M&S is adding even more ‘Simply Food’ store space.
And M&S have yet to make the all-important decision on how much UK clothing and home store space is going to have to be closed as more and more of the market moves online.
But this nettle will have to be grasped this autumn, despite the potential disruption and upheaval it will cause, just as M&S hope that by “listening to their customers” things will improve.
Of course, those same customers, young and old, male and female, have an increasing number of other retailers to choose from when they want to go shopping. And the world is not standing still waiting for yet another management regime change at M&S to have an impact.
The near 10% slump in the M&S share price today shows that the honeymoon for Steve Rowe is over and the City is braced for things to get worse before they get better.
- Nick Bubb has been a leading retailing analyst for more than 30 years. He is a well-known commentator on UK retailing and is a founder member of the influential KPMG/Ipsos Retail Think Tank