M&S: “store rotation” = long overdue housekeeping

COVID-19 Market Update – 01/06/2021
Written By:
Stephen Springham, Knight Frank
11 minutes to read

Introduction

This is the 42nd of a series of weekly notes analysing the state of the UK retail market in the light of the COVID-19 pandemic. This note focusses on two key themes:

  • M&S: the painful process of making the store portfolio fit-for-purpose
  • Grocery market: pandemic shifts continue to unwind

Please do not hesitate to contact myself or any of my retail colleagues if you require any further information.


Key Messages

  • M&S reports FY statutory loss of £201m
  • FY revenues down -12% to £8.97bn
  • Food sales down -0.6% overall, +1.3% like-for-like
  • Clothing and Home sales down -31.5%
  • Online growth (+53.9%) does not offset lost store sales (-56.2%)
  • Acceleration of “store rotation” programme
  • Ca. 17 new “full-line” stores over the next 2 years (including some Debs stores)
  • Ca. 30 locations likely to prove unviable
  • Significant churn within rest of M&S portfolio
  • Grocery pandemic trends continue to unwind
  • Food sales fall -0.4% in 12 weeks to 16 May
  • Reopening of hospitality prompts sales dip
  • Basket size falls for 3rd consecutive month
  • Ave. spend per trip lowest since March 2020
  • 58 million more trips to supermarkets vs May 2020
  • Online grocery penetration declines by 50bps to 13.4%

1. M&S: the painful process of making the store portfolio fit-for-purpose

Two major points of focus from Marks & Spencer’s FY results last week: firstly, the trading figures themselves and secondly, the direction of travel on the store portfolio. Many commentators made a link between the two, when actually the latter is a long-term initiative borne much more out of historic shortcomings than knee-jerk reactions to events of the last year.

As was to be expected, the trading figures were all over the place. In terms of the headline numbers, the business recorded a statutory loss before tax of £201m in the 52 weeks to 27 March (-£209m in the 53-week recording period to 3 April). It actually reported a profit before tax and adjusting items of £42m for the 52 weeks, but this was negatively impacted by the costs of restructuring operations and “rotating” the store estate (more analysis on this to follow).

Total revenues fell -12% to £8.97bn during the 52-week period. As a broad-brush summation of huge amounts of detail and heavily nuanced numbers, food out-performed non-food by a much bigger margin than ever, unsurprisingly given that the latter was far more affected by lockdowns over the year. But there is so much devil in the detail.

Total grocery sales were in fact down -0.6%, which, on the surface at least, would appear significant under-performance in a market that has supposedly boomed over the last year (the UK grocery market as a collective whole grew by +5.1% in 2020). But M&S was far more exposed to enforced changes in both working and shopping patterns that other foodstore operators and this was reflected in massively varying performance at its various food formats.

On the positive side, standalone Simply Food stores enjoyed y-o-y growth of +18%; those on Retail Parks grew +7%, while M&S.com (boosted by the tie-up with Ocado) grew +184%. In contrast, High Street stores declined -18%, Shopping Centre stores were down -19%, City Centre stores -33% and Travel Franchise stores were down -82%. A telling microcosm of which locations prospered and where struggled in retail markets generally since the advent of COVID-19.

On a like-for-like basis, food sales were up +1.3%, or +6.9% after adjusting for the closure of hospitality and the adverse impact on the franchise business. Food operating profits were down -9.8% to £213.8m, largely on the back of changes in margin mix, such as a shift away from food-to-go. The Food business incurred extra costs to support customer and staff safety of £49.4m and incentives for non-furloughed staff working through the pandemic of £22.0m.

Predictably, the figures were a lot worse on the non-food side. Although the business dressed up online growth of +53.9% as “partially offsetting” lost store-based sales (-56.2%) as a result of closures, clearly it didn’t, as overall clothing and homewares sales were down -31.5%.

As with food, there was massive variation in terms of store locations. High Street (-56%), Shopping Centre (-63%) and City Centre (-67%) stores would typically make up ca. 70% of Clothing and Home trade in a “normal” year. Retail parks fared marginally better, but were still down considerably (-44%). For all its growth, the online business did not absorb anything like these shortfalls.

Clothing & Home recorded an operating loss before adjusting items of £129.4m versus a profit of £223.9m the previous year. Lower sales were only partly offset by reduced operating costs. There were also unfavourable shifts in margin mix (e.g. formalwear -72% in-store, -15% online, holidaywear -72% in-store, -31% online).

So much for trading performance. As part of its “Never The Same Again” programme, M&S also announced what it termed “accelerating rotation of the store estate”. Sadly, many media channels took the “M&S to undertake further stores closures” line on this when the reality is far more complex. In essence, the pandemic has merely spurred M&S to act more decisively to address long-standing weaknesses.

In a nutshell, M&S is looking to improve the overall quality of its floorspace by investing in larger, prime locations (and actually taking on larger sites in those locations), coupled with relocating to larger, out-of-town stores. This may involve consolidating multiple sites into a single store. A number of stores will also be converted to food-only outlets. The number of full-line stores will decrease, but growth in food will mean that net store numbers will actually increase.

In recent years, 60 full-line M&S stores have already closed or been relocated. At the April year-end, it still operated 254 full-line branches across the country. However, although “practically all Clothing & Home departments in these stores contribute positive cash, some are in long term decline, struggle to cover their allocated central costs as a percentage of sales and cannot justify future investment”.

The full-line portfolio will be streamlined to a fully modernised core of ca.180 stores. This will be split between:

- Ca. 100 stores in Prime retail markets, an increase from the current base of ca. 80. In these markets M&S will invest in renewal, redevelopment, or replacement of existing stores.

- Ca. 80 stores in Core markets, an increase from the current base of ca. 65 stores through investments such as the relocation of high street units to retail parks.

Slightly less clear-cut are the ca. 110 remaining locations, which will be subject to “rotation”. This will mean either converting to a Food-only store or another full-line store or consolidating multiple stores into one. This will leave a tail of around 30 locations which can no longer support a store and these outlets will close, with trade recaptured in nearby stores or online (or so management hopes).

Some of the supporting metrics are interesting. The average Clothing & Home cash contribution margin in 2019/20 of was 25% of sales or £3.0m per ‘Prime’ store. This reduces to 23.4% (£1.3m) for ‘Core’ stores and just 18.5% (£0.9m) for ‘Rotation’ stores. But presumably all of these pale compared to freehold and long-leasehold stores, which are in fact being partly sacrificed to fund the rejig of the portfolio?

Similarly, interesting mechanics to justify the store consolidation process. The example M&S gave was of two now closed stores (Kettering and Northampton) having joint sales of £38.5m and cash contribution of £3.6m, but being in long-term decline. The nearby all-singing, all-dancing OOT store at Rushden Lakes, in contrast, trades far better than the sum of these two parts (sales of £39m, cash contribution of £4.8m) and continues to grow in mid single digits (+6.5%).

It is hard to argue against these metrics, on the condition they are replicated elsewhere and are not unrepresentative. And at least M&S is thinking along the lines of primarily re-distributing spend across stores, rather than fall into the trap of assuming that lost store sales will necessarily gravitate online. Rival Next, for one, would tell them otherwise.

M&S poignantly stressed “there has rarely been a better time to acquire new replacement stores on good terms”. The 17 new or expanded full-line stores over the next two years, for instance, are likely to include a number of former Debenhams sites.

While long leases may have historically constrained M&S’ ability to “rotate”, future closure costs will largely be funded through the disposal for redevelopment of freehold and long leasehold properties. The company has an objective to release at least £200m from these projects, including the Marble Arch flagship on Oxford Street. Clearly, there is a balance to be struck here. Releasing value through strategic redevelopment is one thing, wholesale selling off of the family silver another entirely. For the pitfalls of a full-blown sale and leaseback programme, just observe what ultimately happened to Debenhams...

There is clearly much more to this property strategy that M&S merely taking a hatchet to its store portfolio and blindly hoping that online will fill in the coverage gaps and pick up the slack. On paper, much of it makes perfect sense and it is something of a reflection of the UK retail market as a whole. Fewer locations, but better, larger, more fit-for-purpose stores that are now being afforded the investment they so desperately need.

But the screaming question is why M&S has not done this sooner. Radical as these property manoeuvres may seem, they are in effect long-overdue housekeeping that has been woefully neglected for decades. Compare M&S’ position with that of Next, which has been proactively and progressively managing its store portfolio for years. Surely it is easier (and more cost-effective) to manage this process gradually over the years, rather than retrospectively many years too late? Better late than never is not the most ringing of endorsements.


2. Grocery market: pandemic shifts continue to unwind

Supposedly permanent shifts in consumer behaviour are already reversing. This is true across most retail markets, particularly the grocery sector. The pandemic period was characterised by significant demand spikes, stellar market growth, increased basket sizes, a flight to online and the discounters losing market share to the ‘Big 4’. Last week’s release from Kantar shows significant U-turns on all these metrics since lockdown has been lifted.

According to Kantar, grocery sales for the 12 weeks to 16 May fell -0.4%. Given the strong comp base and the re-opening of hospitality (albeit outdoors-only from 12 April), this slowdown was inevitable. Going forward, it is likely to accelerate, indoor hospitality having re-opened from 17 May. But as Kantar pointed out, grocery sales were still significantly higher than pre-pandemic levels with an additional £3.8bn going through supermarket tills in the period compared with 2019 levels.

No great alarms, nor indeed surprises – no one (probably not even the grocers themselves) would begrudge the hospitality sector a much-needed first step towards anything resembling normality. Positive but ultimately artificial drivers that underpinned grocery growth are also unwinding. Basket sizes also fell for the third straight month, while average spend per trip (£22.82) was at its lowest level since March 2020 as shoppers began to move away from the pandemic-influenced big weekly shop.

Perhaps more significantly, Kantar observed that “as the vaccine roll-out moves full steam ahead, consumers are getting more confident about venturing back out to stores”. And some. Shoppers made 58 million more visits to the supermarket this period than they did in May 2020. The greatest acceleration was in Greater London, where shopping trips were up by more than a quarter.

Accordingly, online grocery penetration declined to 13.4% from 13.9% in April (these figure somewhat higher than the “official” ONS figure of 10.5%). Some of the heat in online grocery has inevitably dissipated, but the fact remains that online grocery sales remain much higher than 2019 levels.

Further declines in online grocery penetration levels are inevitable going forward, but that is not to say it is ex-growth by any means – any growth it achieves in more normal times will be organic and ultimately much more valuable than artificial peaks seen through the pandemic.

For a second straight month, both Aldi and Lidl again grew market share, with sales up 5.2% and 4.6% respectively. Aldi’s market share growing 0.4 percentage points to 8.1% and Lidl’s by 0.3 percentage points to 6.2%. Normal service resuming there too.

But the ‘Big Four’ also grew market share over the period. Asda was the biggest gainer, with sales up by +1.9% over the 12 weeks and share increasing to 14.4% from 14.1% last year. Sainsbury’s grew sales by +0.7%, while Morrisons was up by +0.3% , but Tesco sales remained flat versus last year. All secured an additional 0.1 percentage point of share (Tesco 27.0%, Sainsbury’s 15.1%, Morrison’s 10.0%).

Ocado remained the fastest-growing grocer during the period, although sales growth has slowed substantially year-on-year to +15.4%. Ocado’s share of the market over the period stood at 1.8% versus 1.6% this time last year.

COVID-19 has supposedly changed everything. Or has it really? Permanent consumer shifts are proving to be increasingly temporary. But clearly, we’re not just going to go back to where we were before. On balance, COVID-19 is proving a “kicker” to underlying trends in retail, rather than the complete course-changer others purport it to be.