May 19, 2016 / 12:52 PM / in a year

No pain, no gain: M&S boss to map out rocky road to recovery

A Marks & Spencer logo is seen on a shop in downtown Brussels, Belgium March 10, 2016.Yves Herman

LONDON (Reuters) - The new boss of British retailer Marks & Spencer MKS.L will deliver some uncomfortable truths to investors next week: turning around its clothing business will require yet more costly change and could squeeze short-term profits.

Chief Executive Steve Rowe will set out his strategy to shareholders on May 25, almost two months after he replaced Marc Bolland at the top of the 132-year-old firm, a UK institution that has fallen out of fashion over the last decade.

For generations, M&S dressed British shoppers of all ages. But the advent of fast, cheap fashion at one end of the market and affordable luxury at the other - combined with fierce online competition - has left it struggling to return to its glory days.

Company veteran Rowe, 48, must convince investors he can lure shoppers back to its clothes - part of its flagship general merchandise division - and make progress in matching the success enjoyed by its upmarket food business.

"The general merchandise business has struggled for years to gain any momentum so we'll be looking to see the extent to which Rowe can turn that around and how credible the strategy is," said Simon Gergel, chief investment officer for UK equities at Allianz Global Investors, one of M&S's top-40 shareholders.

"We've had lots of false dawns from this company."

Rowe's plan is likely to involve more price cuts and improving the quality of clothes, according to analysts, while he could reduce the number of the retailer's fashion brands, which include Autograph, Limited, Per Una and Indigo.

With an increasing number of goods sold online, the CEO could also kick off a review of M&S's use of store space, including how much space should be devoted to food and to clothing, and its nearly 900 locations and office requirements.

M&S declined to comment for this story.

Londoner Rowe has promised a straight-talking approach to arguably the most prestigious and high-profile job in UK retail. His message will be that he can fix general merchandise - clothing, shoes, accessories and homeware - but it won't come cheap and investors will have to be patient, particularly as UK consumer confidence appears to be waning.

The division accounts for around two-thirds of group profit, so its success or failure will determine his own fortune as CEO of a company where he has worked for over half his life.

"This business needs to go through quite significant change and there will be some pain attached to that," a person with knowledge of the situation told Reuters on condition of anonymity.

"Because of the type of pain we've got to put ourselves through there will be costs associated with that. That will affect profitability for a short term."

MORE SURGERY

Dutchman Bolland addressed decades of under-investment by spending billions of pounds on supply-chain logistics and a new website during his six years in charge.

But while the food business outperformed the market, he failed to deliver a sustained rise in clothing sales to accompany the profit margin gains he did achieve. Shares in M&S have fallen by about a quarter over the past year.

Though his investment means M&S is through the really big capital expenditure projects, more surgery is required and that would involve additional costs. If those are not offset by savings elsewhere, profit will be dented.

A survey by analysts at RBC Capital Markets of 18 British mass-market clothing retailers found M&S' lowest - or entry - prices were around 20 percent above the average.

Rowe has already cut the prices of 315 spring clothing lines by 10-15 percent and seen sales volumes rise as a result, but he recognizes M&S has further to go. Continuing improvements to the way the firm sources products, which have helped to lift the gross margin, should soften the blow from any further price cuts.

"There's a balance between gross margin, pricing, promotions and making sure we've got absolutely competitive values in the high street," Rowe told reporters last month.

While fourth-quarter clothing sales fell year-on-year, they showed an improvement from the previous quarter.

Rowe also needs to push through more improvements to product availability, so M&S doesn't run out of popular ranges and sizes, while its customer service - once acclaimed - now lags that of rivals, analysts say. But all these changes come with a cost.

Rowe, who ran M&S's food business before taking charge of the clothing and homeware division last July, is keen to boost cross-selling between the two sides of the business. That task will he helped by mining data from the Sparks loyalty card, which since its October launch has signed up 4 million members.

The CEO wants M&S to be a simpler, more agile, business and has already streamlined his top management team with more concentrated responsibility and accountability.

"Removing additional layers of bureaucracy should go a long way to helping the business become more dynamic," Columbia Threadneedle Investments, M&S's sixth-largest shareholder with 2.9 percent of its equity, told Reuters.

Analysts say some of M&S's more marginal overseas divisions, such as its loss-making business in China, could also be closed.

LOST GROUND

Though M&S remains Britain's biggest clothing and footwear retailer by value of sales, with a market share of just over 10 percent, it has struggled to compete with the fast fashion of Zara (ITX.MC) and Primark (ABF.L), and lost ground to traditional rivals like Next (NXT.L) and John Lewis [JLP.UL].

At the same time supermarkets Tesco (TSCO.L), Sainsbury's (SBRY.L) and Asda (WMT.N) have all raised their clothing game.

The results for M&S's 2015-16 year will also be announced on May 25. Analysts are on average forecasting a 2 percent rise in group pretax profit of 673 million pounds ($983 million) - a second straight year of profit growth following three years of decline.

For the 2016-17 and 2017-2018 years, the company-compiled analyst consensus profit forecast currently stands at 710 and 744 million pounds respectively.

Some analysts expect Rowe to downgrade those expectations with the promise of sustainable earnings growth from 2018. M&S's dividend is seen as safe but some think a share-buyback program started by Bolland will be put on hold.

M&S' capital expenditure has been on a downward trajectory.

"Confirmation that there will not be another wave of investment capex will be taken positively," said Columbia Threadneedle.

"There are still a lot of operational improvements which can be made in the general merchandise division and we'd hope that Rowe will take the necessary decisions to push the business forward."

Editing by Kate Holton and Pravin Char

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