Marks & Spencer Plc.
The company has performed well in the underlying area however its performance has been impacted by a series of non-underlying items. The trading profitability is consistent with prior years. While sales have been higher than last year for the Food business, the Clothing and Home segment has not been able to depict a top line growth.
Headquartered in London, Marks and Spencer plc is a giant multinational retailer that enjoys a premium listing on the London Stock Exchange (Corporate.marksandspencer.com, 2017). Founded in 1884 it deals in the retail of luxury food products, home products, and clothing (Corporate.marksandspencer.com, 2017). While it has experienced several peaks and troughs in the past, it has recorded global annual revenue of £10.4bn (M&S, 2016, p.18). Throughout the UK the company has 914stores along with 468 stores across Europe, Asia and the Middle East making a total of up to 1,382 stores globally (M&S, 2016, p.1). The sections that follow analyse the company from five different perspectives namely profitability, liquidity, working capital management, solvency, investment, cash flow and share price movement. Detailed calculations are appended with the report (appendix 1).
Gross Profit Margin
Trading profitability has been almost stagnant over the three year period. The G.P margin which stood at 38% in 2014 remained at 39% for the next two years. Margins were better in subsequent years courtesy of the Clothing and Home segment that evidenced an increase of 245bps year on year (M&S, 2016, p.15). While the UK Food Division experienced pressures from the increase in waste costs and deflation from price investment, the Clothing Division was able to show a good progress year on year where improvements were mainly driven by better buying margins on the back of the implementation of direct and flexible sourcing operation and effective sourcing initiatives (M&S, 2016, p.12). Resultantly, while the total revenue of the company grew by 2.4% in 2016, its cost of sales only increased by 1.6% thereby translating into a favourable gross profit margin growth.
The ratio measures the efficiency with which a company uses its assets to generate revenue. The asset turnover ratio for the company stood at 1.33 in 2014 which deteriorated to 1.28 in 2015 and 1.27 in 2016. While the average total assets increased by approximately 3.8% year on year, the total revenue only managed to increase slightly. Additions to total assets, in 2016, mainly took the form of retirement benefit assets and an increase in cash and cash equivalents thereby signifying that the company was not productive in its use of resources (M&S, 2016, p.87). In 2015 the increase was mainly driven by an increase in the value of intangible assets, retirement benefit assets, and cash & cash equivalents (M&S, 2015, p.91). It can be argued that while the total number of stores of the company increased from 1,253 stores in 2014 to 1,382 stores in 2016, the increase in the value of assets has not translated into higher total revenue (M&S, 2016, p.1).
Net Profit Margin
The net profit margin while remaining stable at 5% in 2014 and 2015 declined to 4% in 2016. While it was seen that the gross profit margins had improved year on year, the impact could not be translated into a better net profit margin as the company found it difficult to control cost. The net profit stood at £506m in 2014 which declined by 5% in 2015 and by a further 16% in 2016. The decline was mainly driven by an increase of 1.8% in UK operating costs on the back of higher employee incentive costs, higher depreciation, and growth in Food selling space leading to an increase in overheads (M&S, 2016, p.23). Moreover, there was an increase in non-underlying items which dented the overall performance in 2016. These mainly comprise bank charges, costs for UK store review, UK one-off impairment costs, international – impairment of goodwill and other international impairments (M&S, 2016, p.24).
Return on Equity
In line with the declining net profit, the return on equity also showed a downward trend. ROE in 2014 stood at 19% which fell to 15% in 2015, and 12% in 2016. Whereas the net profit was down year on year, the total equity improved by 18% in 2015 and 7.6% in 2016. Improvements were mainly driven by re-measurements of retirement benefit schemes and the overall profitability for the year (M&S, 2016, p.88). With the overall profit for the year declining year on year, the falling ROE is a worrying indicator for shareholders.
Return on Capital Employed
The ratio measures the operating profitability of the business as a proportion of the net operating assets employed in the business. For the underlying operations the ROCE stood at 14.8% in 2014 which later improved to 15% in 2016. The primary driver for a better return is the small decrease in the average net operating assets and an increase in underlying earnings before interest and tax.
The current ratio measures the overall liquidity position of the business. The current ratio of the company stood at 0.58:1 in 2014 which slightly improved to 0.69:1 in 2015 and remained at the same level in 2016. It can be argued the company does not have enough liquid assets to repay its short term debt obligations. So for example, in 2016 the company only had £0.69 worth of liquid assets to repay every £1 of short term liabilities. This can be a worrying sign for providers of debt and the shareholders. Whilst there has been a noticeable increase in the value of cash and cash equivalents, the improvements have not been able to catch up with the short term liabilities of the business (M&S, 2016, p.87). The declining levels of liquidity were evidenced by an increase in borrowings and other financial liabilities which increased by 7% in 2016 along with an increase in current tax liabilities and liabilities arising from derivative financial instruments (M&S, 2016, p.87).
The quick ratio also proxies liquidity however in doing so it eliminates the inventory from the calculation as they are often difficult to liquidate (Sale, Salter and Sharp, 2004). Eliminating inventories, the quick ratio of the business shows a sign of worry. The ratio in 2014 stood at 0.22:1 and then slightly improved to 0.31:1 in 2015and then remained at the same level until 2016. As M&S operates in the retail sector the quick ratio is less relevant for the business as its inventories of food items and clothing liquidate quickly. The facts are reiterated by the company’s treasury and financial risk management policy which states that the liquidity and funding are the principal financial risks faced by the company (M&S, 2016, p.112). The funding requirements of the company are mostly met by syndicated bank facilities, medium-term notes, bank borrowings and retained profits. With a combination of a balanced long-term debt maturity profile and a diverse range of cash flows the company ensures adequate short-term liquidity headroom (M&S, 2016, p.112).
Working Capital Management
The ratio measures the frequency with which the inventory is sold and then restocked (Grubor, Milicevic and Mijic, 2014). The inventory turnover ratio stood at 8 times in 2014 which then declined to 7.7 times in 2015 before rising to again 8 times in 2016. In terms of days, the company has maintained an inventory of almost 45 days on average. For retail business like M&S a stock turnover ratio of 45 days may appear to be on the higher side however given the seasonal nature of the business some inventory levels must be maintained. The UK Clothing and Home segment suffered in 2016 due to difficult weather patterns (M&S, 2016, p.15). While the UK domestic market was wet in the summers, it was warm in autumn which meant that there were difficulties encountered in selling inventories quickly. Resultantly, the sales of the Clothing and Home division fell by 2.2% year on year. Slightly higher inventory build-ups were experienced in the run up to Christmas as prioritising availability was the main focus (M&S, 2016, p.15). During 2016 the company expanded its product range by introducing 1,700 new products which also added to the inventory holding during the year (M&S, 2016, p.15).
Trade Receivables Collection Period
Accounts receivables turnover ratio measures the number of times a business collects its debtor balances. While the ratio was 37 times in 2014 it declined to 33 times in 2015 and 2016. The total receivables collection period which stood at 10days in 2014 slightly increased to 11 days in 2015 and 2016. The figure for trade and other receivables comprises supplier incomes that have been earned but not invoiced.
Lower receivables collection period is also attributed to the M&S online store. In the year 2016 alone, around 7.4 million customers purchased online where sales increased by 23.4% (M&S, 2016, p.16). Given the retail nature of the business a majority of the collection from the customer is done upfront hence there is very little working capital that is tied here.
Trade Payables Payment Period
The ratio measures the length of time it takes for a company to settle its trade payables (Koen and Oberholster, 1999). In 2014, it took the company on average 91 days to pay its trade creditors. The number increased to 96 days in 2015 before declining to 93 days in 2016. On average, over the three year period, the company took 93 days to settle its creditor balances. On the procurement front the company has been quite successful as it has not only sourced the materials at lower margins but has also secured credit from suppliers on favourable terms (M&S, 2016, p.11). The cash conversion cycle of the business on average stands at negative 35 days courtesy of the favourable credit terms negotiated with suppliers. The company has also reduced its dependency on suppliers as it designs 65% of its clothing ranges in-house and the plans are to increase this number to 70% (M&S, 2016, p.10). The company has nine regional sourcing offices that employ 450 staff who continuously negotiate favourable terms (M&S, 2016, p.11). Many of the company’s suppliers have been supplying the company since last 20 years while some have worked with the company for over 75 years (M&S, 2016, p.11).
Alternatively known as gearing, the debt to equity ratio shows the financial leverage of the business (Buljevich and Park, 1999). It expresses the long term debt obligations of the business as a proportion of the total equity employed by the shareholders. The Debt-to-Equity Ratio of the company in 2014 stood at 61% which lowered to 55% in 2015 and 52% in 2016. While taking on debt can result in tax benefits a ratio too high can result in significant solvency risks (Damodaran, 2012). The long term debts of the business have evidenced a compound annual growth rate (CAGR) of 3.5% whereas the equity has recorded a CAGR of roughly 13%. This has led to a decline in the overall gearing levels of the firm.
The fact has also been confirmed by the statement of cash flows which shows that in the year 2015 the company repaid £165.7m worth of borrowings and repaid £10m and £20m worth of syndicated loans in 2015 and 2016 respectively (M&S, 2016, p.89).
Debt to Capital Employed Ratio
The ratio expresses the long term debt of the business as a percentage of the capital employed. The ratio stood at 30% in 2014 before declining to 29% in 2015 and 28% in 2016. While the capital employed in the business has improved year on year courtesy of the increased investment in the total assets of the business, the long term debt portion has decreased over the three year period. The ratio therefore confirms that the debt component only makes up around 30% of the net operating assets. It also signals that much of the net assets employed in the business are financed through equity.
The balance sheet of the business shows that cash and cash equivalents stood at £182.1m as at 29 March 2014, £205.9m at 28 March 2015, and £247.6m at 2 April 2016 implying that the company is generating positive cash flows allowing it repay its long term debts when they fall due (M&S, 2016, p.87). While the build-up of cash has contributed favourably to the net operating assets it has reduced the need to obtain external debt finance which consequently led to lower financial leverage.
The interest coverage ratio depicts the ability of the company to service its debt obligations when they fall due (Stickney, 2010). The ratio stood at 5 times in 2014before increasing to 6 times in 2015 and then eventually declining to again 5 times in 2016. This shows that the company is in a comfortable position to pay its finance costs. While the levels of debt have very slightly increased over the three year period, the number for finance costs has declined. This is primarily due to improved year on year pension net finance income and interest income from other short term investments (M&S, 2016, p.24).
The decline in the operating profit is lower than the fall in the value for finance costs which has resulted in improved ability of the company to service its debt obligations. Put simply, on average, a company can pay interest five times out of its current operating profits thereby placing it in a comfortable position.
Cash Flow Movement
The company has generated positive operating cash flows in all three years. While the net cash inflow from such activities was £1,129.6m in 2014, the figure improved to £1,278m in 2015 and later declined to £1,212m in 2016 (M&S, 2016, p.89). The improvements were mainly driven by better cash flow generated from operations which in turn improved as a result of better trading profitability, effective management of working capital, and one off contributions in the form of non-underlying operating profit items (M&S, 2016, p.120).
For any business that is to continue operating as a going concern, it is vital that the business generates positive cash flow from operating activities. The cash flow movements for M&S to this end confirm that the business is viable and is generating sufficient cash flow from its operating activities.
The cash outflow from financing activities in the year 2014 was £498.1m, which increased to £614.5m in 2015 and £631.4m in 2016 (M&S, 2016, p.89). The increase in cash outflow is mainly attributable to the repayment of bank borrowings, repayment of syndicated loan notes, the payment of equity dividends, and the cash outflow pertaining to share buyback (M&S, 2016, p.89). In 2015 the company repaid £165.7m worth of bank borrowings, £10.2m worth of syndicated loan notes repayments, and £280.7m worth of equity dividend payments which accounted for major cash outflows during the period (M&S, 2016, p.93). In 2016 main cash outflows pertaining to financing activities were £113.5m of interest payments, £19.9m syndicated loan notes repayments, £301.7m worth of equity dividend payments, and £150.7m worth of share buyback (M&S, 2016, p.89).
During the period under review the company received cash from the exercise of share options by company employees. The inflow in this regard amounted to £44.2m, £40.8m, and £20.6m in 2014, 2015, and 2016 respectively (M&S, 2016, p.89).
The net cash outflow in respect of movements attributable to investing activities amount to £614.9m, £649.1m, and £576.1m respectively (M&S, 2016, p.89). Major outflows to this end fall under the category of the purchase of property, plant, and equipment (PPE). Purchases of PPE in 2014 amounted to£ 440.1m which increased to £521.8m in 2015, and then declined to £363.3m in 2016 (M&S, 2016, p.89). The increase in capital expenditure is consistent with the number of stores opened by the company in the UK and internationally over the three year period.
Major cash outflows here also pertain to the purchase of intangible assets amounting to £201.5m, £178m, and £186.8m in 2014, 2015, and 2016 respectively(M&S, 2016, p.89). In 2016, a one-off cash outflow was also incurred which was associated with the acquisition of the subsidiary where the consideration paid amounted to £56.2m.
Share Price Movement and Performance
A preliminary review of the share price movement for the last five years shows that the stock has recently been trading at a five year low of £317 per share (Bloomberg.com, 2017). As of 11:35 AM EST 01/20/2017 the stock is currently trading at £343.3 per share (Bloomberg.com, 2017). The market capitalisation is 5.578b GBP and the current P/E ratio is 22 times (Bloomberg.com, 2017). The share clocked a 52 week high of £442 per share on 22 May 2016 which was right after the company made public its audited financial statements (Bloomberg.com, 2017).
The underlying earnings per share (EPS) in 2014, 2015, and 2016 was 32.2p per share, 33.1p per share, and 34.8p per share respectively (M&S, 2016, p.18). The improvements in EPS were mainly driven by the improvements in the underlying profit as the number of shares outstanding over the year remained almost flat.
The dividend per share declared increased from 17p in 2014 to 18p per share in 2015 (M&S, 2016, p.18). In 2016 the board recommended a total dividend of 18.7p per share. The dividend yield over the three years has been sub-par meaning that shareholders have benefitted mainly from share price appreciations. The current P/E ratio at 22 times however indicates decent investor confidence who are optimistic about the future potential and earnings capability of the business.
All in all, it can be concluded that the company has performed well in the underlying area however its performance has been impacted by a series of non-underlying items. The trading profitability is consistent with prior years. While sales have been higher than last year for the Food business, the Clothing and Home segment has not been able to depict a top line growth. However, it has yielded good margins on the back of sourcing efficiencies. The liquidity position as depicted by the current and quick ratio appears to be an area of concern as the business appears to be short on liquid assets that are vital in discharging the short term debt obligations. On the solvency front the company has managed to lower its financial leverage by making debt repayments which is further supplemented by a decent interest coverage ratio. With respect to the management of working capital it is observed that the company has a favourable cash conversion cycle courtesy of the better credit period offered by suppliers and lower inventory holding periods and receivables collection period. Lastly, the share price has fluctuated significantly over the last five years and has until recently remained at low levels, however, a decent P/E ratio signifies the investor and market confidence on the earning capabilities and potential of the company.
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M&S, (2015). M&S Annual Report and Financial Statements 2015. London: Friendsstudio.
M&S, (2016). M&S Annual Report and Financial Statements 2016. London: Friendsstudio.
Sale, J., Salter, S. and Sharp, D. (2004). Advances in international accounting. 1st ed. Amsterdam: Elsevier JAI, p.90.
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Appendix 1: Ratios
Appendix 2: Excerpts from the Annual Report 2014
Appendix 3: Excerpts from the Annual Report 2015
Appendix 4: Excerpts from the Annual Report 2016
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