On your marks

Marks & Spencer is already the biggest commercial user of the Channel Tunnel and soon even more of its lorries will be spreading the gospel according to St Michael farther into Europe and beyond.

Britain’s favourite retailer, the only one with a triple A credit rating, is planning a massive expansion programme, involving a 2bn investment in the next three years. It is partly aimed at sharply increasing the share of the company’s revenue generated from overseas stores.

M&S makes no secret of the reason behind the move: its ambition is to be well on the way to being truly global by the year 2000. Its immediate aim is to raise the revenue on business done outside the UK by early next century from a threshhold of 17 per cent to as much as 25 per cent of the total take.

It is the scale of the programme which has caused surprise in the City. After all, M&S has been an international retailer for mote than 20 years, initially with limited success. So what’s behind this sudden desire to travel?

Partly it’s because a business like M&S cannot be satisfied with the single-digit earnings growth evidenced in last week’s interim results. Partly, too, it’s opportunism, since the strength of sterling abroad means M&S is in a good position to acquire property. And partly it’s because, after long years of slow growth abroad, it is now confident enough to do something a little more spectacular.

M&S’s financial results were re-ceived with a little disappointment last week. It announced interim pre-tax profits of 452.3m for the six months to September 27, up 5.2 per cent over the same period the year before, but lower than expected as a result of changes to pension funds after the last Budget and the effects of currency exchange rates.

Turnover was 3.74bn, up 5.9 per cent. International turnover rose 1.8 per cent to 601.3m while operating profit fell 17.2 per cent to 22.2m – profits were reduced due to the ef-fects of currency exchange and be-cause of the cost to international subsidiaries of importing UK goods.

There was particular disappointment with the food division, which saw turnover increase by only 2.3 per cent. Analysts were quick to point out that the major supermarkets had successfully moved into higher-margin food retailing, where M&S has made a killing in the past.

The group’s financial services division was hit by increased competition too and, though turnover rose by over 28 per cent, operating profits were up only 13 per cent. But it is perhaps an indication of expectations about M&S that such re sults are regarded as disappointing.

However, it would be wrong to conclude that significant growth in the UK market is over.

The company plans to boost its floorspace in the UK by 2 million sq ft, from its present level of 10.5 million sq ft. M&S will open separate women’s standalone stores for the first time as well as adding to the number of in-store bakeries, butchers and delicatessens – although the company rubbishes as “absolute nonsense” suggestions that it is readying itself for an assault on the UK supermarkets.

M&S’s plans to open “home” stores – which stock for example small electrical appliances but no food or clothing – have been applauded by analysts, who see this as a growth area. Its decision to expand a currently limited mail order operation by offering clothing for the first time, from next spring, was also welcomed.

Despite some analysts’ reservations, primarily over the inevitable slowdown in returns in the first few years of the expansion, the business is undeniably sound.

“It is in a strong position but if you have a dominant 16-17 per cent of the total clothing market in the UK then however good you are, there are limitations to share gains in the future,” says John Richards, retail analyst at NatWest Securities.

So M&S’s expansion plans should be seen against a backdrop of considerable potential for further growth in the UK, albeit not on the scale it has enjoyed in recent years because of increasingly fierce competition from other retailers.

Now however, with sterling’s strength abroad at a high, is an opportune time for international expansion.

It’s been a long time since M&S’s first store opened in Europe – Paris in 1975 – and the record has been mixed. M&S’s early stores in Canada opened to less than popular acclaim.

“When M&S opened in France in the Seventies the idea was that, because hordes of French besieged the M&S store in Folkstone, the same thing would happen in Paris. But at the time only three per cent of French people had heard of the company,” says Richards.

M&S has learned its lessons, such as the necessity of employing local management, and has proved it can transfer its success abroad.

The acquisition of the US store chain Brooks Brothers in the Eighties was initially frowned upon by the City, but the chain’s half yearly operating profits in the US and Japan rose 109.1 per cent to 2.3m compared with the same period last year, and M&S has franchised the company into the Far East. So it is gaining experience all the time.

In Europe, the bulk of the planned expansion will be in Germany, France and Spain.

Since opening its first store in Cologne earlier this year, M&S has already acquired a further four sites in Germany and chairman Sir Richard Greenbury says there are 20 to 25 sites in Germany alone which M&S would like to have tomorrow: “My guess is that it will take us five years to get them.”

Now is the right time to buy since the German market is in its fifth year of retail recession and falling property prices have reduced start-up costs. So far, sales at the Cologne store have “slightly exceeded expectations”, says the company.

It is only when there are a reasonable number of stores across Europe that M&S is likely to see the economies of scale it requires: at the moment stock in the Cologne store, for instance, can be replaced within 48 hours (from warehouses in the UK) but it is costly to serve just one outlet in this way.

M&S European division chief Clive Nickolds has admitted as much: “You can’t make money with one store. If we can open ten stores in Germany by the year 2000 then we would be comfortable.”

There is no chance however, says M&S, of matching the 14 per cent rate of return on sales achieved in the UK since German staff costs are 70 per cent higher while business taxes are steeper too. But as the clothing market alone is two-and-a-half times as big as the UK’s, M&S is prepared to live with this state of affairs. But it does plan to raise profitability to the continental European average of about half British levels over the next three to five years.

In the Far East, M&S has ten stores in Hong Kong, where trade is suffering following the reduction in the tourist trade by over a third since the handover back to China in the summer. The long-term plan is to use these stores as a springboard for expansion in China.

Japan is also under consideration. In the past the price of property has proved too formidable a barrier to entry for the company. However, M&S’s preferred method of operation so far in the region has been through franchises, which substantially reduce capital costs. And this has proved to be a wise strategy. Tumbling stock markets in the Far East have badly dented property prices, but left M&S’s position relatively unscathed.

“Chains like Eddie Bauer, the US clothes store, have made it so it can be done,” says Carolyn Simons, director of management consultancy Management Horizons.

Greenbury says the ambitious nature of the expansion programme is vital if M&S is to reach critical mass – and gain substantial improvement in international profitability.

Although analysts shaved pre-tax profit forecasts for next year by 65m to 1.16bn and are understandably worried about the scale of the investment planned, the pay-back on the plan is long-term and, judging by M&S’s recent performance overseas, the City will be pleased to see more green and gold lorries trundling through the Channel Tunnel than ever before.