Background to Marks and Spencer Group

A British global retailer with approximately 1,382 outlets

A British global retailer with approximately 1,382 outlets, M&S Group is registered on the London Stock Exchange and operates in both domestic and foreign markets. The main market is the United Kingdom, which has over 900 outlets and at least 450 locations abroad. Turkish, Russian, Greek, Irish, and French-speaking nations in Europe account for the majority of global markets, with India coming in second. Sales of high-quality food items, home goods, and clothing are how M&S makes money. These products are available in stores and online to customers in the U.K. and other countries.

Financial Performance Assessment

Profitability

Marks and Spencer Group profitability seem to be declining because of the decrease in the operating and net profit margin. Each dollar of sales earned an operating profit of $0.068 which fell to $0.055 in 2016. Such margins are small showing that the company’s expenses are on the rise and it is worrying because it means there is a small proportion of revenues available to cover the non-operating costs. Every dollar in sales earned $0.047 in net profit which declined to $0.039. For M&S, its ability to generate net profit from its revenue is on the decline and investors and creditors would be worried.

Each dollar of M&S stockholders equity made $0.152 in net profit in 2015 that fell to $0.118 in 2016; an indication is that the company is not efficient in utilizing is stockholder’s funds in making profits. Every dollar of the company’s capital employed earned a profit (operating) of $0.115 which declined to $0.091 in 2016. The decrease in ROCE shows that M&S is not efficient in deploying the invested capital. Creditors and investors prefer a higher ratio because it indicates that the company can pay interest and have enough profits to distribute to the equity shareholders.

Liquidity

Marks and Spencer liquidity position is unfavorable because the liquidity ratios are less than 1. The current ratio was constant at 0.69 over the two years meaning there are 0.69 times current assets as there are current liabilities. However, the problem is that it is less than 1 which means that the current assets are not sufficient to cover the current liabilities and the company may experience challenges in paying the short term obligations when they fall due. The quick ratio has also remained unchanged at 0.31 showing that M&S has insufficient quick assets to meet its short-term obligations when they fall due. The cash ratio increased from 0.10 to 0.12 an indicator that M&S cannot pay its current assets using the available cash and cash equivalents. The company needs more than its cash reserves to pay off its current liabilities and creditors would be worried because it shows the company does not keep sufficient cash balances and it could resort to disposing of the long-term assets (Atrill and McLaney 2017, p.223).

Efficiency

Analysis of the efficiency ratios shows that Marks & Spencer is effectively utilizing its assets to generate revenue as well as manage operations. M&S asset turnover has remained unchanged at 1.7 over the two years, and it shows that every dollar of M&S assets generated a revenue of $1.7. The asset turnover is favorable because the company is making higher sales from the capital it has invested. The fixed asset turnover was also constant at 1.5 showing that each dollar of its fixed assets generates £1.5 in revenue.

Marks and Spencer in 2015 took an average of 46 days before it sold its inventory and this declined to 45 days in 2016. The inventory turnover means that it sold its inventory an average of 7.9 times in 2015 which increased to 8 in 2016. A larger inventory turnover is favorable because it means that the company is selling its inventory more times thereby minimizing inventory costs, reducing obsolescence, and improving liquidity by converting inventory into cash within a few days (Correlli 2016, p. 3670).

The day’s receivables have also decreased from 5 in 2015 to 4 in 2016 showing that the company takes a lesser time to collect its receivables, an indicator of efficiency and aggressiveness. The company took 56 days to pay its vendors and suppliers, and it has increased to 58 days in 2016. M&S credit policy is efficient because the company collects cash from debtors 14 times before it pays the suppliers.

Solvency

Marks and Spencer debt to equity ratio for 2015 was 1.56 which declined to 1.46 in 2016. Debt to equity ratio of 1.46 means that there are 1.46 as many liabilities as there is equity, that is, for the year 2016, creditors had a larger stake in the company than the equity holders. Such a high ratio is not favorable because it shows that the equity holders do “not have much game” in the business. The company’s interest cover has also declined from 2015’s 6.13 which means that it has enough earnings to cover its interest expense 6.13 times to 2016’s 5.21 which shows that its earnings can only cover its interest expense 5.21 times. Marks and Spencer can comfortably meet its interest expense from its earnings, and there is no imminent risk of inability to pay.

Investment Potential

Marks and Spencer investment potential are not bright because the investment ratios have been declining over the two-year period. For the year 2015, each share of outstanding stock earned a net income of $0.298 which declined to $0.249 in 2016; meaning the ordinary stockholders would receive less income (Atrill and McLaney 2017, p.232). The price-earnings ratio has also declined over the two-year period indicating that the market is willing to pay a lower price for its stock (Li, Wang, and Dong 2014, p. 287) based on its earnings. For the year 2015, investors were prepared to pay $17.8 for each dollar of Mark and Spencer’s earnings which declined to 16.36, a clear indicator that the market is not optimistic about its future performance.

Reappraisal of Marks and Spencer Financial Performance

From the chairman’s statement, M&S is in a state of change because of the new CEO who has come in and the transformation of the business processes to competitively compete in today's’ digital age. M&S continues to deliver value to its shareholders through its progressive dividend policy where they will earn a final dividend of 18.9p, a 3.9% increase from the previous year. The chairman acknowledges that the business performance was not satisfactory, he calls it mixed, with statutory profits for the year 2015 falling by 19.5% to £483.3 million. The food segment was the standout performer despite the competitive environment its distinctive offers, newness, and innovation, and emphasis on convenience (M&S: Annual Report & Financial Statements 2016, p4) provide great value to customers. However, the chairman points out that the international business, especially Europe, faced significant challenges as a result of currency fluctuations, the slowing growth of the global economy, geopolitical unrest (Bloom 2014. 160).

From the CEO’s statement’s, it is evident that the customer is at the heart of everything that M&S will do moving on forward. The strategy is to achieve sales growth through the recovery of the underperforming clothing and home section and leveraging greater growth in the food business. For the clothing and home business, the focus will be on the product, quality, fit, the price, and a better customer experience. Priorities in the food business are building on the strengths of quality, innovativeness, and choice, improved convenience by extending the Food store program, and commitment to value by competitive pricing (M&S: Annual Report & Financial Statements 2016, p7). The CEO is also committed to driving greater profitability for the shareholders through tighter control over its costs and cash as well as improving shareholder returns through improving dividend payments.

The marketplace report points out that consumer confidence has suffered from wider macroeconomic issues to blame. Factors that caused uncertainty and reduced consumer spending included uncertainty over the EU referendum, worries over a slowing global economy, and the growing threat of terrorism. Also, the report reveals the shopping behavior of U.K consumers and they are Europe’s largest online buyers of clothes, use multiple channels, and require product choice and ranges tailored to their needs in convenient locations. The report also states that M&S food business market share grew from 4.1% to 4.3%, a testament to its uniqueness, newness and innovation, and quality. However, the clothing line is underperforming as indicated by the 2.2% sales decline because customers cannot locate what they need in the stores and the lack of core wardrobe choices. As a result, the company is implementing radical changes to ensure the segment regains its sustainable profitability and competitiveness.

From the operating review, M&S food business stands out because it is special, new, and different and sales increased by 3.6% with marketing share rising to 4.3%. The strategic focus is to offer real choices, greater convenience. The clothing and home business underperformed and the strategy to reinvent the line is more major focus on in-house designing, improvement in availability and fit clothing, and reducing prices. The operating review also highlights the challenges facing international business where profits declined by 39.6%. M&S focus will be on adapting to the changing customer behavior to ensure that they have the best shopping experience and one way is to improve the online business where customer satisfaction is guaranteed.

From the KPI and financial review, M&S financial objectives are to grow group revenue, increase earnings and returns, and strong cash generation. The KPI for group revenue is total group sales which rose by 0.8% for the 2015/16 financial year. The KPI for the increase in earnings and returns is underlying profit before tax, ROCE, underlying EPS, and dividend per share and M&S posted growth in all these areas for the 2015/16 year. The KPI for strong cash generation is free cash flow (per shareholder returns) which rose by 2.9% during the financial year. The financial review reveals M&S commitment to the delivery of shareholder return by a progressive dividend policy which pays twice and the returning of any surplus cash through share buyback programs and special dividends. Also, M&S is committed to strong capital management through reducing net capital expenditure and seeking openings that promise strong returns.

M&S risk management framework involves the identification, assessment, and mitigation of the various risks and their possible impacts. The risk management review identifies 11 principal risks that affect its business model (operations) and whose mitigation is possible. Also, three external risks over which M&S has no control over have been identified as sociopolitical unrest, deterioration in foreign exchange and the global economy, and the uncertainty surrounding Brexit. Operational risks include changing consumer behaviors and information security, and a description of each risk, the impact, and the mitigating actions have been described. M&S has also added new changes such as seeking to define and measure the appropriate risk appetite and assessing the company’s long-term viability in light of the 11 principal risks.

Recommendation to Investors

An analysis of the company’s profitability reveals that it declined over the two years as evidenced by the fall in the net profit margin, the operating margin, the return on equity, and ROCE. However, a drop in profitability does not mean that the business fundamentals are weak, but it is a result of a challenging international operating environment and underperformance of the clothing and home business line. With the new CEO, the strategic focus of the company seems to be back in line and the expectation is that the home and clothing business sales will improve and the food business will grow stronger.

The company’s liquidity position is not encouraging because the current ratio and quick ratio are less than 1, an indicator that the company may face difficulties in meeting its short-term obligations. The efficiency ratios reveal that M&S is efficient in the utilization of its assets in the generation of revenues and it has an aggressive credit policy because it collects money from debtors 14 times before paying suppliers. The investor ratios are not encouraging because of a decline in the EPS and P/E ratio, but M&S has a stable dividend policy.

Therefore, my recommendation would be a buy for any investor whose interest is receiving dividends. M&S dividend policy is progressive, and the company is committed to shareholder returns in the form of dividends. An investor has the assurance of annual dividends from investing in M&S. However, for the investor seeking to profit from capital gains as a result of price appreciation, I would not recommend investing in Marks and Spencer Group Plc. The small growth in sales and profits as well as the challenging and challenging retail environment as a result of the shift to online and digital shopping will impede M&S posting impressive growth in its sales and revenues.

Limitations of Ratio Analysis

The use of only two years is the first limitation of the analysis. A longer period, at least, five years is needed to draw deeper conclusions and insight on the state of M&S operations. The analysis has relied heavily on financial ratios which have some limitations. The first limitation is the use of historical accounting figures presented in the financial statements. The financial statements are subject to approximations and even manipulation, and therefore, the reliability of the ratios is in doubt. More so, accounting information is historical, and as a result, one cannot rely on financial ratios as a basis for making future predictions and investment decisions.

Financial ratio analysis does not factor in the effects of inflation which distorts the financial statements. According to Lesakova (2007, p.262), the recorded values are different from the true current values particularly concerning assets and inventory. Therefore, care and judgment are needed when carrying out and interpreting ratios. Also, interpretation of ratios is subjective because it's hard to decide when a ratio is good or bad. For instance, M&S current ratio is 0.69 meaning that it is bad and the interpretation is that it will not meet its current liabilities. Under such conditions, the company would be nearing bankruptcy where it has liquidity problems but this is not the case with M&S and therefore, judging a good from a bad ratio is subjective and relies on individual judgment.

References

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M&S Annual Reports and Statements. (2016). Annual Report. [online] Marks and Spencer Group Plc., pp.1-20. Available at: http://annualreport.marksandspencer.com/M&S_AnnualReport_2016.pd [Accessed 28 Jun. 2017].