Marks and Spencer kitchen sink avoids drama

Food fumble

Faster than expected gross margin slippage in food was the biggest disappointment. There had been signs that M&S’s price and cost mix was well-calibrated to growing challenges facing grocery retailers amid input cost inflation. Instead, M&S has managed to take almost the full brunt of the hit in in the first half. Admittedly that was the cost of limiting retail price increases. But with steady like for like declines across both quarters against pockets of growth among competitors, it is clear M&S food market share was under pressure. We think these conditions were exacerbated by M&S’s response. The group has put its opening programme for the Simply Food format on hold. It now wants to reposition its food offer for future growth.  The statement is puzzling. Investors had thought ‘repositioning’ was the aim of the Simply Food programme itself. Essentially M&S seems to be starting from scratch. That is a worry amid strengthened offers at Tesco and Morrisons. There is also scant further detail about the M&S’s new stance on food, apart from “sharpened prices”. Together with an aggressive promo response to the challenging environment, food moves began to blur the earlier impression of a tighter focus that emerged when Steve Rowe took control last year.

Clothing & Home encouraging

We get less of a sense of incongruity with Clothing and Home. To be sure, the 0.7% like-for-like decline there was poor, though no break from the norm. Additionally, the second quarter showed strong improvement to a dip of just 0.1% from -1.2% in Q1. Plus, the 5.3% uplift at full prices was notably better than results achieved by arch rival Next. Outperformance backs M&S’s view that C&H self-help is rendering “encouraging” results. Unfortunately, M&S online clothing and merchandise continues to lag. We were struck again by what appears to be poorly communicated sequencing of the group’s plans to improve digital C&H sales. We would like to think M&S had recognised some time ago that its general merchandise supply chain “needs to be faster and lower cost” and that “digital fulfilment capability” needs more investment to speed up growth. Official recognition had of course begun much earlier. But the date of a hard reset at C&H will be later than most investors were expecting.

No kitchen-sink drama

As kitchen sinking by British retails giant go, the one staged by M&S’s Steve Rowe has been a very gradual one. That pace has the advantage of reduced drama but it has possibly reduced shareholder visibility on execution. Nevertheless, the rapid resolution of lossmaking issues overseas was a clear success story. Together with headway on cost control and a cogent path to continued free cash flow growth, the next key inflection points for Marks are likelier to be improvements and not deteriorations. Indeed, we note Marks & Spencer has avoided the type of protracted discussions about its progressive dividend that other large consumer groups have wrestled with. True, underlying free cash flow growth was little more than flat in H1 and negative after the interim pay out, whilst net debt rose 5% to £2.03bn. However, excluding one-off effects from store closures and ending the defined benefit pension scheme, cash flow goals remain cogent. Low-hanging fruit from further cost initiatives also underpin the outlook for shareholder returns. Marks & Spencer’s margin for error remains limited, but little occurred in the first half that points to significant deterioration. And after the stock’s 6% decline this year, the forward rating of 11.7 times is not demanding.

Technical chart

M&S’s stock chart underlines the holding pattern the company has been in for almost 18 months as the path to improvement remains difficult and slow. Note the range of some 40 pence or so that has prevailed since the end of July last year to date, aside from a brief 8 weeks; between mid-April to mid-June. The weekly view in the first chart below shows that such disappointments go back far longer. The shares are struggling to contain relinquishment of gains since late 2008 to around 61.8%. That the stock is below that long-term Fibonacci is interpretable as negative. Clearly, should the range we outlined give way to the downside, an increase in volatility can be expected. The question is, will it? Well the prognosis is not brilliant. The trusty 200-week moving average (blue line) way finder is now dipping and weekly momentum (see RSI sub-chart) is also waning.

Daily intervals in the second chart below corroborate the range over a year and a half, though the price looks somewhat more underpinned in one-day resolution. Support around 306p occurred three times between September 2016 and late August 2017. The flat lining 200-day MA also at least keeps the idea of eventual stabilisation alive, as it contrasts with the falling 200-week MA. For now though, the 200-DMA secures a resistance zone of 324p (200-DMA) and c. 355p (observed resistance for about a year). Confluence with the 38.2% Fibonacci retracement of M&S’s failed rise between Brexit vote recovery and 2017 highs in May, seals the fate of the stock for the foreseeable future.