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Edited Transcript of MKS.L earnings conference call or presentation 22-May-19 1:00pm GMT

Full Year 2019 Marks and Spencer Group PLC Fixed Income Investor Earnings Call

London Jun 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Marks and Spencer Group PLC earnings conference call or presentation Wednesday, May 22, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Humphrey Singer

Marks and Spencer Group plc - Chief Finance Officer & Executive Director

* Joanna Hawkes

Marks and Spencer Group plc - Group Treasurer

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Conference Call Participants

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* Charles Watford

PIMCO Europe Limited - Analyst

* Karan Samtani

BNP Paribas Global Markets - Trading Desk Analyst

* Louise Parker

Bloomberg Intelligence - Credit Analyst

* Rebecca Clements

Fidelity International - Senior Credit Analyst - Fixed Income

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Presentation

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Operator [1]

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Good day, and welcome to the M&S Fixed Income Call for 2018-2019. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Humphrey Singer. Please go ahead, sir.

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [2]

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Good afternoon, and welcome to the fixed income call. As I've just been introduced, I'm Humphrey Singer, the Group CFO, and I'm here today with our Group Treasurer, Jo Hawkes.

I will quickly recap on the update we gave investors this morning before moving on to Q&A.

So on a reported basis, group sales were slightly down at GBP 10.4 billion. Adjusted profit before tax was in line with market expectation, down around 10%. Gross profit was down in both Clothing & Home and Food, although this was partly offset by the reduction in operating costs. Statutory profit before tax was up, primarily due to lower charges associated with our transformation plan this year, although these charges do remain significant. We generated GBP 729 million in free cash flow before the cash charges associated with our adjusting items, and consequently our net debt was down.

Turning to the Food business, sales were down as expected. We have the adverse timing effects of Easter both at the start of the year and the end of the year. And we are making deliberately a move to a more trusted value by investing in base prices on over 400 lines and reducing promotional complexity. However, we did see an underlying improvement in transactions, volumes and sales in quarter 4.

We added 48 stores in the year, although the effects of new openings has been increasingly offset by closure of both Full Line and Simply Food stores.

Gross margin was slightly down in line with guidance. The effects of price investment and input cost pressure was largely offset by lower promotions and our cost saving program.

Turning to Clothing & Home. In Clothing & Home, sales were down, driven partly by the increasing effects of our store closure program. We delivered a solid online performance, which we believe was ahead of the market.

Margin was up in line with guidance. Across the year as a whole, buying margin was slightly down, I think to adverse FX, but this was more than offset by the reduction of stock into sale.

Turning to International, constant currency sales were up, excluding the exit impacts of businesses that we've departed and the sale of the Hong Kong business. Profits were slightly down, partly driven by investment in market-right pricing.

Costs. U.K. operating cost decreased by 1.2%, slightly ahead of where we'd guided. As anticipated, there was a rebuild of a certain number of costs in the second half, such as marketing and supply chain.

Cost growth in the business from inflation in areas such as volume and channel shift were more than offset by our significant cost saving programs.

Interest. Our interest charge decreased as a result of the repayment of the bond in December 2017.

Turning finally to CapEx and cash flow. We generated strong free cash flow across the year. There was a working capital inflow reflecting both a reduction in stock levels as well as some timings on payables. CapEx remains well controlled. We had a number of cash outflows relating to our strategic programs, but overall, we were able to reduce net debt by GBP 282 million. I would now like to turn it over to take any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will now take our first question from Rebecca Clements from Fidelity International.

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Rebecca Clements, Fidelity International - Senior Credit Analyst - Fixed Income [2]

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I have a couple of questions, if that's all right. I'll just start one-by-one if that works for you.

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [3]

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Sure.

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Rebecca Clements, Fidelity International - Senior Credit Analyst - Fixed Income [4]

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The first question is just around the Ocado JV and I appreciate -- I'm not asking about the rights offering or anything like that. But going forward, I appreciate that it'll be a JV. So it will probably just be a line item on your balance sheet and a line item in your income statement. But from a reporting perspective, are you planning on giving more granularity than that in your commentary, et cetera, going forward? I mean, what kind of KPI trackage can we expect?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [5]

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Yes. I mean we've not fully landed on those. To be honest, we've not even completed the deal yet, that happens in July. We will, as you say, have it as relatively high-level lines in balance sheets and shares of profit. But I'm sure we will share metrics and KPIs. I can't give you that list today. Of course, we'll be dependent on an agreement with our JV partner. So we'll have to be consistent in terms of how we share data, and I'm sure they also will also share information about the JV. But I know that doesn't fully answer the question, but there will be more information, I'm sure, shared.

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Rebecca Clements, Fidelity International - Senior Credit Analyst - Fixed Income [6]

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Okay. Fair enough. And then regarding logistics and what's going on there. I guess the first question is what categories were most impacted in Clothing & Home by the availability issues?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [7]

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It was really -- I guess, the biggest impact was in lines where, funny enough, we had great products. So there is an element of this which is being a victim of having much better product. And so examples that have been highlighted in the fourth quarter perhaps was around Womenswear jeans lines, which were, we think, significantly improved in terms of how they were received by customers and the fit and what have you, styling. And we probably hadn't had the confidence after many, many years of seeing declines to know exactly how much of those products to buy. So now that's no excuse. The merchandisers should have done a better job, again, of getting availability in there, but it is partly that. So the key lines that suffered were really Womenswear and in particular, the lines that had been reshaped more recently.

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Rebecca Clements, Fidelity International - Senior Credit Analyst - Fixed Income [8]

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Okay. So it's not really a -- it's not a system issue or a logistics issue per se? It's more of a merchandising issue?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [9]

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Yes. Correct. And actually, of the 2 problems to have, not having great products or -- and obviously you'd rather have both, but actually getting the product right is really super important than some would say harder. The merchandising bit, we really should be doing a much better job on that and I think we absolutely can. And like I said, part of it is about building confidence. When you get the right product, we have very, very large customer traffic and we can sell a lot when we are the largest -- have the largest market share in Womenswear jeans, which most people wouldn't guess. And so we can sell a lot when we get it right.

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Rebecca Clements, Fidelity International - Senior Credit Analyst - Fixed Income [10]

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Okay. So I guess I shouldn't confuse that with what I thought was also commentary this morning about maybe going a bit too far, because you have reduced inventory quite a bit, which generally is positive, but the implication -- unless I was not understanding correctly, the implication was that perhaps those -- it was a bit too far?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [11]

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A bit of that. The truth is what we should be able to do is both, balancing availability and stock. I mean, that's the job, isn't it? It's easy to do one and not the other, while quite easy to one and not the other. But what you've got to try and do is both and maybe there were examples where people were focusing too much on the stock to cover KPI. But we've reduced 3 weeks, but from very high levels. And frankly, overall, we should be able to get better availability and further reduce stock cover. But undoubtedly, now you didn't misunderstand, there was probably a, in some cases, too much focus on stock cover and not enough about having availability of great product.

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Rebecca Clements, Fidelity International - Senior Credit Analyst - Fixed Income [12]

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Okay. And then that leads into working capital. Obviously, you had to a use of working capital last year and you had a benefit this year, but you did allude to that being more of a timing issue, I think. But how should we be thinking about working capital in the future in the context of your store opening and closing schedules and also the JV?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [13]

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Yes. So the JV would be completely separate, because we'll run that in a separate way. And so -- and actually, stock cover issues are really a Clothing & Home issue for us, not a Food issue. Obviously, you have much lower levels of stock on Food.

Sorry, coming back to the working capital bit, yes, there were timing issues both from the prior year unwinding where we'd had an outflow, some of that was timing. And then again, at the end of this year, some benefits, which will unwind next year. Underlyingly, though we had reduced stock cover, which, absent the availability issue, is a good thing, as you said. So looking forward, I think it will probably be volatile as we go through sorting out this stock versus availability point. But we should, in the longer run, not necessarily all next year, but see some improvement in our stock cover down towards more who we might benchmark ourselves against competitively externally. So I think there's more room for improvement, but I'm not predicting that that will happen in the year ahead.

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Rebecca Clements, Fidelity International - Senior Credit Analyst - Fixed Income [14]

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And then in terms of restructuring costs and the accrual aspect of that, is there cash out next year for costs you've already accrued or are we going to see -- are we going to have new costs reported next year?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [15]

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So you'll have a bit of both actually, so -- and I've guided on this, this morning and there's some detail in the RNS and the accounts as they come out. So we had GBP 145 million of exceptional cash this year, some of which obviously was from programs we had booked and launched in previous years. We will -- there will for those pre-existing programs be more charges in the year ahead in the way that the costs get spread over, over time, particularly with the proxy restructuring. And I guided on cash to being broadly similar to the number that we've had as an outflow this year. After that, it tails off reasonably quickly. But yes, we have got more to do in sorting our -- particularly our store portfolio out.

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Rebecca Clements, Fidelity International - Senior Credit Analyst - Fixed Income [16]

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And so when you say broadly similar this year, you mean like around GBP 145 million? That's what you're referring to?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [17]

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Correct. Yes.

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Rebecca Clements, Fidelity International - Senior Credit Analyst - Fixed Income [18]

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Okay. Okay. And then on the debt specific questions. You had said that you -- on the morning call that you don't want to rely on your bank debt or your RCF. Are you referring to not using bank debt to refinance bond debt? Or are you referring to use of your RCF throughout the year or what was the context for that statement?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [19]

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Kind of both. So we have an RCF that we aren't currently using and haven't actually used for quite a period of time. And that feels to me -- although, I mean, I'm not adverse to using it, but I wouldn't want to, in a sense, end up structurally using large portions of that for long periods of time. I think in the market conditions we're in not just about us, but about the market generally and the sector that we trade in, the way we'd like to run this is not to be reliant on bank debt. And that was part of the equation for the whole bundle of considerations that then led us to do the -- launch the rights issue and cut the dividend for that matter.

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Rebecca Clements, Fidelity International - Senior Credit Analyst - Fixed Income [20]

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Okay. And then last question for me. Regarding your upcoming maturities, because obviously you have GBP 500 million of current debt on your balance sheet. Is it fair to say that it's based on what you just said about bank debt that you would likely refinance that with another bond?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [21]

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We haven't made any firm decisions as yet. Yes, we got a GBP 400 million bond that matures in December of this year. But we will have a good look at that once we've got through the rights issue. So it wouldn't be surprising if we did choose to refinance at least part of that.

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Operator [22]

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(Operator Instructions) We will now take our next question from Karan Samtani from BNP Paribas.

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Karan Samtani, BNP Paribas Global Markets - Trading Desk Analyst [23]

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I have just a couple of questions. So the first question, could you -- are you able to provide any data on the shrink in the Food business?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [24]

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Do you mean the shrink as in -- what type of shrink you mean? As in losses of Food or waste or...

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Karan Samtani, BNP Paribas Global Markets - Trading Desk Analyst [25]

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Yes, yes, yes, waste. Waste.

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [26]

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Yes, so we've -- waste. Yes, we're not terribly public about exactly what that percentage is, but I think we've been clear that it's higher than we want it to be. So now partly that's because we manage a business that's -- it makes much more into fresh products than some of the mainstream big 4 food retailers. And frankly, it's one of the aspects of the transformation where we've done some work, but it's not yet got visible results. We have improved our recovery rates on what -- when food gets towards the end of its life, we've put in place routines and ways of maximizing the revenue on that product is getting close to its sell-buy days. So the net waste number actually has improved a bit. But the gross waste is still much higher than we would want it to be, quite a few percentage points higher than our competitors would experience.

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Karan Samtani, BNP Paribas Global Markets - Trading Desk Analyst [27]

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Okay. So as you run the JV with Ocado, I guess you will sort of get some benefits from that and sort of run that through the business?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [28]

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Well, no, because remember we're running that as a completely stand-alone operation. So what we might get from them is insight in how to do a better job. We will be open to that for sure. But no, because that's a very discrete separate type of business, it will run as it runs today through their CFCs, they have extraordinarily low levels of waste. We need to do a better job in our store operation.

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Karan Samtani, BNP Paribas Global Markets - Trading Desk Analyst [29]

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Okay. My second question is, are you able to share anything on the capital structure of the JV? Because there were some comments on that it would be self-funding this morning. So just wondering what the capital structure would look like.

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [30]

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Yes. So it is stand alone again in that sense. There is a facility set up, if you read the gory detail of all of the various prospectuses and circulars. But of course, the 2 partners can choose to loan modest amounts of money in just in the sort of working capital funds. But I mean, very, very small numbers of tens of millions or whatever. Actually, the plans that we share together and have signed up to, if you like, for the next number of years show that even as they expand that business should be self-financing, and so that's the way it's been set up.

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Karan Samtani, BNP Paribas Global Markets - Trading Desk Analyst [31]

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Okay. So there isn't any expectation that there would be a capital injection from you either as a partner slated down during the course of the JV?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [32]

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No, no plans to do that at this stage. No.

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Karan Samtani, BNP Paribas Global Markets - Trading Desk Analyst [33]

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Okay. And my third and final question I think has been already answered. Yes, it's been answered.

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Operator [34]

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We will now take our next question from Louise Parker from Bloomberg Intelligence.

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Louise Parker, Bloomberg Intelligence - Credit Analyst [35]

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Can you hear me?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [36]

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I can now.

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Louise Parker, Bloomberg Intelligence - Credit Analyst [37]

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Okay, sorry, I was on mute. I just wanted to get back to something that was talked about on the call today, maintaining your investment grade rating. Obviously, you can't look at a crystal ball and see what the rating agencies are going to do, but Archie Norman said something and he said it might be out of your hands if you, in order to maintain the investment grade rating and I think management today said that your leverage is certainly higher than where it needs to be -- the debt metrics -- to retain investment grade. I mean, you haven't commented on...

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [38]

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Yes. So let me clarify that.

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Louise Parker, Bloomberg Intelligence - Credit Analyst [39]

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You haven't commented on these as yet.

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [40]

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Yes. So I think Archie was making the same point that you've made just now actually, which is, of course, it's not in our control to say what a rating agency might or might not do. So I think that it was no more than that, pointing out that we can structure our business in a way where our metrics are all commensurate with an investment grade company and we believe we're in that place right now, albeit I didn't say give some color, which is the leverage levels if they improved a bit which plans suggest they might over the next couple of years, that would move us back into a more comfortable place. But at the end of the day, it's up to the rating agencies.

The other key point is even if all your metrics as we are, are in the right place, there are other more judgmental factors that they take into account. So they will have a view on U.K. retail, they will have a view on Brexit and its impacts on consumer confidence, a view on trends in the industry and that's all, at the end of the day, quite important. So I think that was an innocent remark, not to be read too deeply into, I think.

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Louise Parker, Bloomberg Intelligence - Credit Analyst [41]

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Okay. And just a follow-up on that. I mean, obviously, you have an objective to maintain an investment grade rating, with respect to your refinancing is that you did come back to the bond market to refinance the GBP 400 million bonds maturing this December. I mean, how do you see that having an impact on your cost of funds?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [42]

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Well, just to clarify, we have a -- our objective is to maintain a capital structure commensurate with investment grade rating, like I said, and I'm repeating myself really, but we can't then decide what the rating agencies might or might not do. I mean, clearly, if you're at a different rating that might well have an impact on what coupon you get on any bond issuance. And -- but market factors would also have quite a big impact too. So -- obviously, in thinking about how we finance our business, we would be driven by what we think is the right requirements for our balance sheet at the right moment.

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Operator [43]

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(Operator Instructions) We will now take our next question from Charles Watford from PIMCO.

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Charles Watford, PIMCO Europe Limited - Analyst [44]

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A couple of questions just to clarify things. First of all, your other financial assets increased up to GBP 142 million. Can you just give us an idea of what that is and is it counted as cash for you?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [45]

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Yes. I think that's referring to short-term investments that we have for the surplus cash that is currently in the business and it's longer-term and it's -- in terms of its maturity, which is why it is in that camp.

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Charles Watford, PIMCO Europe Limited - Analyst [46]

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Understood. But you could use it, for instance, for repaying the bond or something along those lines which is working capital for you...

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [47]

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Depending on the exact maturity of the -- off the top of my head, I can't tell you exactly what the length of maturity rate. So it might be buried somewhere in the accounts actually what that is.

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Joanna Hawkes, Marks and Spencer Group plc - Group Treasurer [48]

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Yes. I mean we could do, but also bear in mind, at the end of the year, that we're at peak cash. So we will be using some of that cash as we go through our working capital cycle, and our refinancing at the end of the year would be based on also the strategic outlook of our long-term debt consumption.

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Charles Watford, PIMCO Europe Limited - Analyst [49]

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Okay. Understood. Then just to try and follow-up on something else. What happened to online in Q4 in the Clothing & Home? So we saw a slowdown in growth. Is this to do with the lack of availability or is there something else there?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [50]

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A couple of things really. So first of all, there was some availability issues, which no doubt hampered our sales growth. The other thing is the comparisons year-on-year were a little bit unusual. So we were comping against a weaker, the year before, Q3 and a stronger Q4. So actually, if you look to the year on 2 years for, say, Womenswear, it's much more consistently and pretty strong growth. So I know people and some of you can disappear somewhere if you go on year on 2 years, but I think that is a point to make. And there was some timing at promotions. But to your point, I mean, undoubtedly, if we'd had better availability and back to the earlier conversation, I think we could have done a better sales number in dotcom.

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Charles Watford, PIMCO Europe Limited - Analyst [51]

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Understood. And then maybe just the final question for me is the -- one of the headlines that came out of this morning's call was you expect sustainable profit growth in 3 to 5 years. I suppose the other side of that is then you expect profit declines for the next 3 years at least. Could you...

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [52]

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Well, you can have another scenario which is flatter market. Yes, if you looked at consensus from the actually -- some -- or any analysts, actually, you'd find that service -- that actually sell-side analyst consensus is broadly for flattish profit for next year and the year after and then we're talking about growth in that 3- to 5-year time period.

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Charles Watford, PIMCO Europe Limited - Analyst [53]

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I guess just your earlier comment that you expect exceptional cash out this year to be similar to last year, but then to go down the following year, implies that a lot of the restructuring will be done in the next -- will have been done in the next 12 months. Or is that reading too much into your comment and you still have more to do the following year?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [54]

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We've got loads to do, but whether that results in adjusting items entries or not is a different question. And we've still got a lot of the store program to deliver and the way that that appears in the books and in the cash flows over, in some cases, a reasonably long period of time. If you sublet a lease and provide for the difference between the sublet and what you've got but you're paying more on the top of the lease, then that's -- that will last over the length of the lease. So the cash outflows can be over quite a long period of time. But I mean, I wouldn't imply that we're, in any sense, not -- we're still in stage 1 of this multi-year transformation. Yes, like I said, there is a bit of a disconnect sometimes between that and what actually appears in the P&L adjusting item line.

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Charles Watford, PIMCO Europe Limited - Analyst [55]

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Understood. Maybe just one follow-up then. On the sublease amount, what is that cost that you're now paying per year for effectively someone else's leases or the top-up?

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [56]

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So we don't break it out in that much detail because it will vary store by store. So some stores we exit if we get the right deal on an assignment or a surrender upfront and then you get larger outflow upfront. Others, it's, like I say, it's spread over time. So you can see in the detail of our -- in some of the detail beneath the cash flow statement, how much the outflow was last year from memory, somebody is having a look for me has reminded me that bottom -- at the footnote at the bottom of the working capital shows us at GBP 20-odd million -- GBP 27 million in our store closure program in the year just gone.

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Charles Watford, PIMCO Europe Limited - Analyst [57]

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Right. Okay. And that will be recurring or a lot of that will continue then for at least...

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [58]

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Well, some will continue, yes, to be as it had, yes, I mean, obviously in both of what we book for stores is noncash and that's why that number of GBP 145 million is so much smaller than the overall P&L charges we've been taking the last couple of years.

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Operator [59]

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There are no further questions in the phone queue at this time. I would like to hand the call back over to you, Mr. Singer.

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Humphrey Singer, Marks and Spencer Group plc - Chief Finance Officer & Executive Director [60]

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Listen, thank you very much indeed for all your questions and for listening today. I'm sure you will be in touch if you've got any more follow-up questions in the future. Have a great rest of the day.

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Operator [61]

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This will conclude today's conference. Thank you all for your participation. You may now disconnect.