In FY06 & FY07 a c.6% price reduction drove short-term volume growth of
14% at M&S. However, over the last 10 years the market share held by value
retailers has grown by over 500bps and online penetration has increased by
c.15% points. This time around M&S is operating in a significantly more
competitive environment, and reducing prices by only 2%. Volume uplifts are
therefore likely to be materially lower than in the past. We reduce our FY17
PBT forecast by 14% and our FY18 & FY19 forecasts by >20% implying flat
PBT growth in these later years. We apply a 30% discount to the FY18 sector
average PE to arrive at our new TP of 307p. With a further 14% downside
implied, we reduce our recommendation to UW.
Deflation rate in the clothing market is -6%, but we expect the average
selling price at M&S to fall by only 2%. Although M&S is lowering
headline prices, we expect this to be materially offset by reduced markdown
activity. Overall therefore we expect an average achieved selling price
reduction of only c.2% in Clothing, versus deflation in the Clothing market
of -6% in the last year. We note that in FY07 Clothing market deflation was
-4% versus price reductions at M&S of c.6%.
Gross margin story has run its course. The moving parts in the M&S
Clothing & Home gross margin where we have some visibility, and can
therefore attempt to estimate, would imply a FY17 gross margin decline of -
20bps. This implies a gap of at least 70bps that M&S must bridge to reach
guidance of +50-100bps (JPMe +50bps). We therefore believe that the risk
to this range lies to the downside.
Cautious on the Food outlook. We forecast a flat FY17 Food gross
margin. But with ongoing pressure in the market and some signs of LFL
weakness, we believe the risk to the Food gross margin lies to the downside.
Reduce TP to 307p. The shares have fallen 34% since November 2015.
However, based on FY18E EPS, where we now assume only flat PBT
following a decline of 10% in FY17E, the stock is trading at a discount to
the sector of 18%, versus a 4-year historic average of 22%. As recently as
January M&S was trading at a discount of 30%. We apply a 30% discount/
FY18 PE multiple of 10.0x to arrive at our new, Mar-17 TP of 307p.