I like Marks & Spencer. No really, I do.
I used to buy most of my clothes from M&S back in the late 1980s and early 1990s, when I was in my late teens and early 20’s. The clothes were well made, the designs were mainstream and the consistency of quality and sizing was second to none (at least in my local high street).
But that was a very long time ago and since then M&S has lurched from crisis to crisis, carrying out what seems to be an endless transformation project to “make M&S special again”.
This endless transformation has been incredibly expensive. For example, over the last 20 years M&S has retained about £2.5 billion of shareholders’ earnings to invest in the existing business, to make acquisitions, to buy back shares and so on. And yet, after all that hard work and investment of cold hard (shareholders’) cash, the company’s share price is lower today than it was 20 years ago.
For most shareholders then, M&S has been a disaster for at least two decades.
So in my latest article for Master Investor magazine I wanted to outline two red flags which, for many years, have suggested M&S was a no-go zone for long-term investors:
“”Over the 10 years from 2000 to 2009, M&S employed an average of £2.5 billion of shareholder equity, £2.3 billion of borrowings and £1.6 billion of lease liabilities (discounted at 5% per annum), giving it an average lease-adjusted capital employed of
£6.4 billion. Over the same period, it generated average revenues of
£8.3 billion and, after deducting all expenses, average earnings of £0.4
billion. That gives M&S an averagenet return on lease-adjusted capital of 6.7%””””
John – Am I missing something here? If MKS deployed £6.4Billion over 10 years (£640Million a year) and only yielded earnings of £400Million a year it doesn’t look like a return of 6.7% — isn’t it a negative return?
John Kingham says
Hi LR, the £6.4 billion is average capital employed, not average earnings retained each year.
So the average earnings are £0.43bn per year, which is an average return (£0.43bn) on capital employed (£6.4bn) of 6.7%.
Sorry for any confusion.
The retained earnings in that 2000-2009 period came to £1.6bn, which generated something in the region of that 6%-7% return, which is below par and therefore destroying value. Shareholders would have been better off if the company had actively downsized and returned all cash not investible at decent rates of return (7%-10%+) to shareholders (or if it had come up with a better turnaround strategy).
Hopefully that makes sense, but if not then just let me know.
Hi John, Yes it does and at the same time it doesn’t 🙂
If they deployed £6.4Bn and generated only £1.6Bn then it is difficult to determine that it is a return at all, unless of course you consider that any of the £6.4Bn still has any retained intrinsic value — how do you realistically measure that when it has gone into non recoverable fixtures and fittings and costs for continually reorganising – money which in real terms is lost as a cost of doing business.
If there is an argument to say they achieved a total of 6.7% (are we talking annual or over the full 10 years in which case it is a return of 0.67% or therabouts on a linear basis) then yes it is wasted and a return of 1% could be achieved in passive investment with little risk or with another business venture with much better returns and risk associated..
If you consider it is a 6.7% annually then that is pretty good, but I don’t see how you are calculating this figure if the £6.4Bn is effectively dead money.
John Kingham says
Okay, I think the word “deployed” is getting in the way, so let’s forget that word and go back to basics:
Period = 2000-2009
Net Return (average net profit) = £0.43bn
Capital Employed (average) = £6.4bn
ROCE (average) = 0.43 / 6.4 = 6.7%
Now, let’s reintroduce “deployed”. M&S retained (deployed) £1.6bn of earnings during this period (i.e. earnings which weren’t paid out as dividends) to help drive its expansion efforts. There was no noticeable trend of increasing ROCE over the period, so my guess is that the retained earnings generated about the average rate of return, i.e. 6.7% or thereabouts.
The long-run return of the All-Share is about 7%, so that’s less than a market rate of return even though shareholders are taking on idiosyncratic (company-specific) risk, i.e. M&S is riskier than the All-Share so should produce higher returns on retained earnings, otherwise that’s bad capital allocation (or bad execution) by management.
In an attempt to further simplify all this, and perhaps adopt another way of looking at it, especially since Archie Norman took the helm, is to focus on the cash flow statement in the current period and not look at the 2000-09 period which was, well not great. Over the last 5 years working from 2019 backwards to 2015 :-
Total cash from operations 1,239 850 1,068 1,212 1,278 — so this averages £1,130M – so it is reasonably stable in that respect.
Then if you look at the capital expenditure over the same period :-
(313) (349) (410) (550) (700) — this is on a steep declining trend, I guess as more financial discipline is brought into play, Ocado venture excluded.
Then if you look at the total cash dividends :-
(304) (303) (378) (302) (281) — but note this will fall approximately 35 to 40% into 2020 and beyond, you can see that this company could start to declare a greater share of free cash flow, and probably use some of this to further reduvce debt below £2Bn.
On top of that the business is now split 62.5% Food to 37.5% clothing — the food business is still growing – all Archie needs to do is stabilise the clothing sales, (OK it sounds easy doesn’t it?), or really cut the declining rate of this business fall off and bingo, profits will rise, and the share price is likely to get a better rating. Assuming of course M&S has no further need for issuance of new debt – which is unlikely from here I guess, they must have done most of their revamping and strategic alignments with Ocado.
Like you, I don’t like the business, although I still like the company in a kind of nostalgic way, but I’d place a small wager on the share price of M&S returning to an upward trend in the not too near future, but within 18 months to 2 years.
John – Two comments here — Given the emphasis on the destruction of shareholder value, how is it possible that MKS has paid a good dividend over the last 20 years and still reduced it’s debt, and destroyed sharehoder value to that great an extent?
The current price of the shares is clearly a value destruction, if you wanted to sell today, but isn’t it more the fact that nearly all retail (obviously there are exceptions) has come under the spotlight and have been rerated downwards?
If you look at the rating back in 2015 it had a P/E of 16. Today it is 8, and yet its revenue has consistently been £10Bn and its profits have swung all over the place as it has moved from one exceptional to the next as you point out in he article. But still the earnings are still within 20+% of 2015..
Any positive upswing in MKS earnings (Oh there goes that pink pig passing the window again) could see MKS rerating again to somewhere between 8 and 16 P/E perhaps?
Don’t get me wrong, I’m not defending MKS as a good investment, clearly it isn’t in the top or middle echelons, but still, how much of it is the mood of the moment as they say?
John Kingham says
Hi LR, In terms of the destruction of shareholder value, I’m not talking about share price at all.
I’m talking purely about earnings being retained and invested in store refits etc which have generated below market rate returns.
These retained earnings have been sunk into various turnaround strategies which haven’t worked, and with a bit of foresight (i.e. high street retail is a declining market and has been for 20 years, thanks to the world wide web) should have been avoided in the first place.
In terms of the dividend my point is that the dividend should probably have been much larger, with retained earnings being much smaller because of their weak returns. If investors can get better returns by reinvesting dividends into the market index then earnings should be paid out as dividends and not retained (this applies more to mature companies that early-stage companies that are still trying to build scale through low pricing).
My two pence-worth (and I am not a management consultant by any stretch of the imagination) is that M&S should have closed clothing stores much more aggressively and focused on web infrastructure (website, delivery, etc) and food much more as well.
Either way, the company has destroyed shareholder value by reinvesting earnings into capital assets at sub-par rates of return.
So the headwinds are external and beyond the company’s control (i.e. the internet) but management’s reaction to these headwinds was to keep trying to grow the high street clothing business in a shrinking market. And that was a mistake which destroyed shareholder value. In my opinion, of course.
I fully agree with your last statements – it has been a long period of pushing something uphill that keeps rolling back at you. It is only since Archie Norman arrived that the gumption has been adopted to close stores more aggressively – the one in my town closed 6 months ago.
I do wonder if there is still a case for splittng the businesses and that is always muted, but management seem to state not. The rate of growth of the online clothing busness has been quite pedestrian, particularly as it is coming from a small base — perhaps they should work with Next’s distribution system and bite the bullet, swallow some pride and get in with the rest of them.
The Ocado deal looks odd in the sense that for an online approach I question if M&S has the right breadth of products to allow a cost effective delivery service on food, given that all the other supermarkets already now have this. Perhaps they would be better teaming up with Wiltshire Farm Foods given the age profile of the clients — that is a trite statement by the way.
I’ll still buy stuff from the Foodhall, as I’m not averse to being ripped off from time to time and the food quality is usually pretty good.
I really don’t know where it is going — I did buy some of this – not a lot at what I thought was a low price, only for it to get lower of course. With the dividends I’ve collected and a small blip up in the share price I could just be out – but there is this lingering feeling that it will cycle back up to mean revert at some point.
Heh, there’s nowt wrong with dreaming is there?
I feel lucky that many of my investments seem to perform well – M&S is in the dirty laundry box I’m afraid — still to be washed and handed to the charity shop at some point no doubt.
Soon be Christmas — pop down to the M&S Food Hall John with the missus to help prop up my wealth 🙂
M&s future is food. It will be home delivery to the privileged classes. Clothing is going nowhere. Just walk around the stores. Just maybe women are serves okay but men’s is an embarrassment. Ocado was their only hope and I am happy to say it was my suggestion long before it happened. Clothing needs a Per Una moment but today, men if not women, don’t worry about fashion because most clothes are rank bottom unless you have plenty money. Clothes can be categories as low end or high end. I purchased a suit from John Lewis but it was rank awful. No longer a good judge of quality but simply looking at the price. I’m not sure where the middle classes go for clothes. But M&S food is a firm favourite amongst many and Ocado will simplify their purchases.
John Kingham says
Hi Rob. Yep, agree with all of that.
I think I mentioned something of a similar nature in your previous post on M&S:
I personally try to avoid investing in companies which are broken and I think any rationale investor would class M&S a broken company way back in the 00s. Especially if they use the yard sticks such as marketshare, ROE, cash flow and pricing power of a company. However one thing I will say is that it took me a long time to understand all of this. I started reading about investments back 2016 and its started to make more sense now talk about a slow learner.
John Kingham says
Hi Reg, I’ve written about M&S a few times over the years and I don’t think I’ve ever been positive on it. Each time I seem to come up with a different reason not to invest, so there are plenty to choose from.
I agree I think strictly in terms of capital allocation management should have realised by late 80s, M&S had reached its full potential.
If I was management I would have personally invested the excess earnings in other companies such as Walmart, LVMH or Hermes. Ironically by the 80s they had one of the best retail management and would have done a better job analysing their competitors then a top investor.
At the same time the management should have ensured existing business was generating high ROE and sufficient capital was allocated to maintain this position. After all this all excess cash should have been returned in the form of dividends.
In some ways LVMH epitomises this model (however current share price is overvalued). They run a lean business with a few great brands such as Louis Vuitton, Dior, Moet and Hennessy. The excess capital generated by these brands are deployed in three ways:
1) Invest in existing operation to maintain moat i.e. advertising, training of artisans and etc.
2) Invest in other business either as a majority/minority stake. In fact LVMH got chased away by Hermes because they did not want a takeover when LVMH built up a secret stake.
3) The excess capital left over is returned back to the shareholder in the form of dividends.
If you compare this approach to M&S you can see a huge gulf. M&S management failed to realise they were a mature company back in the 80s. They still acted like a young start up. Interestingly this is one of the reasons why I like tobacco companies. Management are completely focused on maximising shareholder returns and do not have any pretension of delusion of grandeur. Their sole focus is strengthening their moat for the long term and generating money for their investors.
Except Imperial Brands as I have mentioned in a previous post:
John Kingham says
Reg, I agree in principle, but it may be a bit harsh (or a bit of a stretch) to think M&S could ever deliver returns in line with Louis Vuitton etc.
Successful luxury goods companies have such strong brands that customers are willing to pay a high price to own the product. On the clothing side, M&S is nothing like that and I don’t see people paying up for M&S clothing just because of the brand. If anything, the M&S brand in clothing is now a negative factor.
Perhaps in food the brand is able to command premium prices, but I don’t think M&S is a high margin high return food retailer. I’m not sure such a thing exists in the UK (or the world?).
I think perhaps something more like WH Smith (which I own a slice of) high street strategy might have worked. In other words, cut costs to the bone, give customers what they want but focus on sucking cash out of the business to be used elsewhere (food? dividends?) rather than ploughing it back in. And face the truth that the clothing business is ex-growth and in long-term decline (there should be no shame in pulling cash out of a business if that’s in the best interests of shareholders).
Anyway, in time we will see how things pan out with Ocado and the company’s current turnaround effort. I wish them good luck, because they’ll need it.
I didn’t mean to turn M&S into a premium brand I meant M&S management should have invested in other retail companies (LVMH) or brands (Nike) i.e. minority investment.
In the 80s and early 90s M&S was gushing out cash and tried to expand into USA and Canada both failed spectacularly. For example they bought a USA retail chain for $750m in 1988 imagine if they invested that in LVMH that would have given them nearly a 8% stake in a company with fantastic business model. The reason they failed to do that was because of sheer arrogance. Management failed to accept that M&S had no more growth left. Instead they just destroyed shareholder value by trying to expand.
I think the only way the company can actually grow is to focus on the food side and potentially become a premium food company globally. This would entail closing all the retail sections and admitting that management have made a hash of things. M&S should take a leaf out of C&A book who quit UK because they knew they couldn’t survive back in 2000. If only M&S accepted the situation and tried to make changes.
Unilever is a company I have so much respect for because it knows when to hold onto its brands and when to move on. Sadly its very unlikely M&S has the management skill to transform itself because it would take a person of strong will to push through all these drastic measures.
John Kingham says
Okay, I see what you mean Reg. Yes, minority investments might have made sense if management had a reasonable expectation of market-beating returns. Personally though I’d rather just have the cash as a dividend so I can do the reinvesting myself.
I agree in principle but M&S management were obsessed with growth therefore they could have potentially achieved this via minority investment. However M&S probably had one of the worse governance culture any company could. Therefore the last thing they cared about was creating shareholder value.
Bob Barnacle says
Reg says, says :-
“Unilever is a company I have so much respect for because it knows when to hold onto its brands and when to move on. Sadly its very unlikely M&S has the management skill to transform itself because it would take a person of strong will to push through all these drastic measures.”
ULVR like MKS has been steadily destroying shareholder value, but in this case by inter-alia taking on debt for share buy-backs above book-value, thereby boosting headline earnings and presumably management remuneration. Neither company appeal to this investor.
Excellent article John – much thought has been applied.
John Kingham says
Hi Bob, the Unilever debt/buyback thing is very strange.
About EUR 6bn came from selling the spreads business, and rather than just giving this to shareholders as a dividend, management decide to buy back shares at near record prices.
At the same time it took on about 6bn of debt for acquisitions? Why not just use the spreads cash to acquire other businesses?
Not that I really care as I’m not a shareholder, but it seems like financial jiggery pokery to please institutional shareholders and boost bonuses somehow or other.
I’d be happy for someone to enlighten me as to why this 6bn buyback/debt/acquisition triangle makes sense.
I would say that Unilever is going through some short term issues including the whole delisting debacle from last year.
However when it comes to operating its actual business to me it seems the company management are fairly rationale and sensible. In the long term Unilever is still likely to exist compare to say Facebook and Microsoft. I could be wrong but that’s just my opinion.