Contents of the in-trays assigned to Katie Bickerstaffe and Stuart Machin, who are set to take up the co-chief executive roles at Marks & Spencer in May, should be predictable enough. Arresting the decline in the clothing and home business, overhauling the store estate and limiting the damage likely to be inflicted by inflation on the margin are top of the pile in restoring the company in the eyes of the investors.
Shares are still priced about 60 per cent below where they were when current boss Steve Rowe took over in April 2016, despite a rally last year. Scepticism remains over whether the new management team will be able to surmount those challenges. An enterprise value of just five times forward earnings before interest, taxes, depreciation and amortisation (ebitda) is almost the cheapest market rating over the past decade.
But the seeds of recovery show signs of taking root. Efforts to stem the decline in clothing and home business have been helped by a growing contribution from online sales. In the six months to October online sales accounted for 34 per cent of the division’s total, a jump from 18.5 per cent four years earlier, and edging closer to a target of 40 per cent. But it has also cut back on the number of ranges it stocks.
Flatlining retailers often buy wide as they attempt to cast many lines in the hope of hooking customers in. For its womenswear range alone, M&S buys roughly 25 per cent fewer options than it did four years ago. The benefits are the ability to gain better terms with manufacturers in exchange for buying greater volume and less stock ending up in clearance sales. Full-price clothing and home sales were up 45 per cent in the third quarter, with those from items sent to the sales rack down 21 per cent.
Those twin effects are starting to be felt on the top line of that business. Like-for-like sales grew 3.2 per cent over the 13 weeks to the start of January against the same period in 2019, the strongest rate of underlying growth in years. The much higher profit margins on clothing and home sales compared with food give added urgency to make that stick.
Advertisement
But clothing sales in store continue to slide. Square-footage that is not bringing sales growth is a bigger drag when you consider the retailer’s large rent bill. Full-line stores, those that sell clothing and food, accounted for about 41 per cent of its £2.1 billion in lease liabilities at the last count. The plan is to cut clothing and home selling space and raise the proportion of floor space dedicated to food, and to reduce its UK full-line stores from 253 to 180 over the longer-term.
Long unexpired leases complicate efforts to cut rents, even if hard-up landlords are willing to make deals. The average lease commitment for the clothing rival Next is about five years, for M&S’s more costly, full-line stores the average unexpired lease stands at about 18 years, if exceptional cases are excluded.
Then there is inflation. In food, rises in the cost of ingredients and packaging will inevitably be passed through via price rises, but including the full impact of higher energy costs associated with running stores and wage inflation is harder. There is also the question of if premium price points might be harder to stomach for consumers feeling the squeeze.
Navigating inflation without hurting revenue growth for its food business adds a layer of jeopardy to Bickerstaffe and Machin hitting adjusted profit forecasts, set at £504 million for the 12 months to March, closing in on the pre-pandemic level.
For all the risks, the paltry valuation attached to the group means the market has set a low bar for the double act to surpass.
Advertisement
ADVICE Buy
WHY The cheap valuation of the shares accounts for the challenges of inflation and the turnaround of the clothing business
Emis
The perceived safety of highly recurring revenue streams has afforded software as a service (SaaS) companies high market ratings. You might think the healthcare software supplier Emis is one of those, with the shares having outperformed the FTSE All-Share more than three times over during the past three years.
But while a forward earnings multiple of 21 might look generous, it is not against what has been on offer over the past three years. Roughly 80 per cent of the group’s revenue is recurring as its larger health division sells software to the NHS.
Hitting a medium-term goal of an adjusted operating margin of 30 per cent could drive its valuation higher. Progress on that score has been impressive: the margin last year came in at 25.9 per cent, up from 22.1 per cent in 2018, when management set out plans to kick-start revenue growth and improve margins.
How might it do that? Cost efficiencies are a starting point, which includes refreshing its existing software systems with new technology. But expanding its enterprise division, which focuses on selling medicine dispensation software to pharmacies and hospitals and partnering with smaller third-party technology providers, is the growth engine for the group. The latter, which involves selling software that integrates with the Emis systems to its NHS and private customers, carries little cost for the group and gives a natural kick to margins.
Advertisement
Adjusted operating profit for the enterprise division grew a fifth last year, accounting for 40 per cent of the group total, on the back of a 17 per cent revenue rise. That’s bang in line with a target to grow the top line at a double-digit rate each year.
Growing market share and offering a broader stable of products to customers are the main avenues for revenue growth there. That included acquiring the training system software provider FourteenFish. Analysts at the house broker Numis raised its earnings forecast for this year by 3 per cent off the back of the deal to 58.8p a share, which is also 6 per cent ahead of last year. Emis deserves more credit from the market.
ADVICE Buy
WHY Sustained growth in margins could prompt a re-rating in the shares