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Edited Transcript of MKS.L earnings conference call or presentation 6-Nov-19 12:30pm GMT

Half Year 2020 Marks and Spencer Group PLC Fixed Income Investor Earnings Call

London Nov 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Marks and Spencer Group PLC earnings conference call or presentation Wednesday, November 6, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Humphrey Singer

Marks and Spencer Group plc - CFO & Executive Director

* Joanna Hawkes

Marks and Spencer Group plc - Group Treasurer

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Conference Call Participants

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* Rebecca Clements;Fidelity International;Analyst

* Vicki Gedge;PIMCO;Senior Vice President

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Presentation

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Operator [1]

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Good day, and welcome to the M&S Interim Fixed Income Call 2019-2020. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Humphrey Singer. Sir, please go ahead.

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [2]

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So good afternoon, and welcome to the fixed income call. I'm Humphrey Singer, 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 onto Q&A.

So in overview, first of all, remember, all the results are now reported under IFRS 16. On a reported basis, group sales were down 2% at GBP 4.9 billion, adjusted profit before tax at 17% down on last year was broadly in line with market expectation, which was pre-IFRS 16. We estimate that impact to have been a negative GBP 7 million on the results, and therefore, actually, results were slightly ahead of expectation.

The Food business is on track with positive like-for-like and with gross margin slightly down, reflecting some deliberate price investments. Sales and gross profit were down in both Clothing & Home, reflecting weaker market, some supply chain challenges and the shape of the buy, i.e., the range and [profit]. This was partly offset by the reduction -- it's quite a significant reduction in operating costs. Statutory profit before tax was up, primarily due to lower charges associated with our transformation plan. We generated GBP 92 million in free cash flow before the cash charges associated with adjusting items, and our net debt was up since the start of the year, but down year-on-year.

Food profits. Sales were up as expected. We have the benefit of Easter timing at the start of the year. And so when you adjust for that, you will see when you look at the -- our net stats that Q2 volume growth was pretty strong and ahead of the market. We have made, I think, good progress in restoring some trusted value, have invested in base price on over 400 lines, and our promotional participation has nearly halved as we had wanted.

Gross margin was slightly down with the effects of price investment and input cost pressure, this being largely offset by the lower promotional activity and our cost-saving program. We opened a number of Simply Food stores in the half, and space contribution to sales is expected to be level for the full year. We completed the acquisition of 50% of Ocado Retail, and we have now recognized that in our accounts. Their performance so far, although it's very early days, when you got a month of their results incorporated is in line with expectations.

Clothing & Home. Sales were down, driven partly by the effects of our store closure program, but also a weaker market and poor availability issues, in particular, contributing to the like-for-like decline. Margin was down. This was caused by a combination of higher sourcing costs. But also some FX impact, increase in discounting deliberately towards the end of the half, we shortened sales period and increased depth of cut, and that contributed to the performance.

International. Overall, sales were down. Owned markets, driven by strong India growth, offset to some extent by our performance challenges in Ireland, consistent with the performance that we saw in the rest of the U.K. or in the U.K. Franchise shipment's also down. It's a combination of 2 things: one, a continuous -- a continuing investment in market right pricing where we invest behind the pricing to our franchisees, and we are seeing volume benefits from that, that are -- will in time pay for that investment. And also, because our partners have got more efficient, some of them around how they manage stock. So although retail sales might be up, our sales into them are impacted. It's a good thing for the system as a whole, but has had an impact in the first half, which we'll probably carry on EBIT in the second half.

Turning to cost. Operating costs were down by 3.3%. So we've got a good pipeline of cost-saving programs that have been consistently delivering. We think by the end of the year, we will -- financial year, we will be 80% through our declared GBP 350 million cost-saving program, so very much on track. And we also had a reasonably significant drop-off in depreciation as some of our investments from many years ago, reached the end of their accounting life. And as we've gone through a phase of, relatively speaking, lower levels of CapEx spend.

Interest. Our interest charge decreased for a number of reasons, including the net lease financing costs reduced by GBP 6.6 million, and we had a modest reversal of an ineffectiveness in our -- one of our currency swaps.

CapEx. Finally, free cash flow after adjusting items, GBP 92 million in the half. We did have some quite material timing impacts within working capital related in particular to stock. So we had more of a normal, I would say, closing stock built this half. The previous year, we'd started with very high stocks. And that meant that we didn't have to build stock as much in the first half. It's quite natural as well to have an outflow in that business in the first half of the year, and you'd expect that to reverse with the seasonality of the business in the second half of the year. And then on top of that, we had some timing issues to do with tax payments. So like everybody who pays U.K. tax, HMRC has accelerated the pace at which they collect that money. So we had 3 payments in the first half of this year, whereas previously, we'd have only had 2, and that obviously will normalize in years going forward.

CapEx remains well controlled, and we've taken down actually our guidance for the full year to GBP 300 million to GBP 350 million. We had some outflows relating to our strategic programs very much in line with expectations. And overall, we saw net debt increase just a bit by GBP 63 million. But like I said earlier, there is a seasonality to our cash flows. We always have a stronger cash inflow in the second half of the year, and I would fully expect that to happen.

So that's a very quick whistle-stop tour through -- of the highlights of the results. I would now like to open it up to take any questions that anybody has.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question will come from Rebecca Clements with Fidelity International.

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Rebecca Clements;Fidelity International;Analyst, [2]

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I have a few questions actually. The first one is on working capital regarding your full year expectation. I appreciate that you had a bit more outflow for inventory in the first half, but should we be thinking about ending inventory levels as being up on last year or flattish with prior year?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [3]

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Actually, down. So we ended the year down a few percent, kind of roughly in line with sales. So no, it was really all about the opening stock position. I would say, to add a little bit more color to what I said just now, that we actually started this year probably light on stock. So it was a sort of double whammy of the previous year we were stock heavier at the beginning, this year we were stock light. And actually, if you look at some of our availability challenges in the first quarter of the year, there is a correlation between those things. So I would expect it to -- that working capital position to go in the opposite direction in the second half of the year.

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Rebecca Clements;Fidelity International;Analyst, [4]

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Right. But do you actually expect for your fiscal year-end -- do you think -- I mean, will inventory be about the same level as last year? Or do you think it should be higher?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [5]

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I think for the end of the year, I would expect us to be down. And I'm not making a prediction about where our sales will be in the second half of the year. Obviously, if sales are down, you'd expect stock to be down. But it's also because there are improvements that this business can and should make to improve deliverable stock cover. I don't think there's enormous amount of upside from that, but there's certainly more to go for in terms of better stock management.

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Rebecca Clements;Fidelity International;Analyst, [6]

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Okay. And then is there anything else in working capital from a timing perspective or one-off things we should be aware of that would impact full year?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [7]

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Yes. Again, to give a bit more color to that, so we had not just clothing stock, but also non-merch -- what we call non-merchandise payments so for supplies and things that were IT or supply chain, logistics costs were just timing where we ended up paying more than the previous half in this year. And again, some of that should unwind.

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Rebecca Clements;Fidelity International;Analyst, [8]

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Okay, okay. And then regarding the improved availability in Clothing & Home versus the first half, it sounds like you are today, kind of, guiding to improvements there. But how are you actually measuring your improvements in availability?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [9]

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Yes, there are very granular measures. We don't always disclose all of them, but obviously by SKU but by -- certainly by groups of SKUs, by categories of product, we measure availability both overall availability in-store, but also availability online, so crucially, obviously, with an online operation with less opportunity to cross-sell people into things that you don't have availability on. So it's even more important to have what -- you have stock behind what you're showing to people. So we measure it in a very, very granular way day-by-day, week-by-week.

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Rebecca Clements;Fidelity International;Analyst, [10]

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Okay. And you're pretty confident that your stock management will be better in the second half? Because it seems like -- I appreciate that sometimes these things can be related to timing differences or ordering and then within your own control ordering patterns. But I guess my question is, how confident can we be that you've resolved some of the availability issues?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [11]

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I think there will be an ongoing battle to resolve availability, and they're not directly correlated. So these stock timing issues and not points in time at the end of particular reporting periods is one thing. But there's an underlying sort of root improvement that needs to be made in the business, which is about improving availability. It's -- I think we're on a trajectory to improve that, but there's still a long way to go.

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Rebecca Clements;Fidelity International;Analyst, [12]

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Okay. And then I might not have remembered this or written it down correctly. But in the slides this morning, I think you were showing the change in costs year-over-year.

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [13]

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Yes.

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Rebecca Clements;Fidelity International;Analyst, [14]

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And I think it -- was marketing cost, GBP 19 million higher or something like that?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [15]

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Yes, that sounds right. So we had a big -- and some of that will be, by the way, phasing. So I wouldn't expect the full year marketing numbers be up as much or to have the same again in the second half. We had some, particularly in the Food business, some big promotional activity for time. Programs like Britain's Got Talent and other pretty successful actually marketing campaigns. The Food business overall is a, I'll say, a more advanced stage in its transformation. And consequently, was at the point where it could successfully, I think, drive business by having more marketing. But it was quite front-end loaded.

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Rebecca Clements;Fidelity International;Analyst, [16]

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Okay. One more question for me and then I'll get back in the queue. And I appreciate that you may not have a definitive answer given that it relates to your position, but is there any update on the timing of hiring a new CFO? And have you confirmed your departure date?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [17]

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So the -- my departure date was [R&Sed], I don't -- want to say a couple of weeks ago, maybe longer, as the end of this calendar year. So that's my timing. I'm off basically Christmas. And there is no announcement yet on my replacement. I know that -- I mean, I'm not involved obviously, but they are actively pursuing that, and I'm sure they'll make an announcement when they're able to.

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Operator [18]

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(Operator Instructions) Our next question comes from Lisa [Easterbrook] with Fidelity Investments.

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Unidentified Analyst, [19]

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In terms of your recent conversations with rating agencies, what is -- how are -- what color can you give us on that? And how -- clearly, the funding for Ocado was positive, but the sales trends in the market remains tough. And how are you feeling about that? And how confident are you particularly with S&P that they understand fully all the changes you're making and the kind of the time frames that we should expect them to take?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [20]

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So we have a very active dialogue with all of the rating agencies. That's something that I've been keen to do in the last couple of years. Certainly while I've been around. And so I think they're fully appraised of information about our plans and the timings of it, et cetera. Actually, S&P came out with a sort of standard update note relatively recently and broadly, weren't really changing their position very much. As you say, we -- I think that a pretty, let's say, debt friendly way of financing Ocado, which I think, from the credit side of the house went down positively. But we do need to transform this business, and part of that transformation, one of the tests for that will be, have we got the businesses back into growth? I think you can see on the Food side, which actually was one of the areas that S&P has been more focused on, bearing growth. And at least in the half, we just had with volumes and now revenues, and that's really encouraging to see. We need to make sure the same thing happens sooner rather than later in Clothing & Home.

And so right now, I think from the company's perspective, we're doing actually everything we can to retain our status as it currently stands. But of course, it's S&P's call at the end of the day or Moody's or whatever.

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Operator [21]

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Our next question comes from Rebecca Clements with Fidelity International.

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Rebecca Clements;Fidelity International;Analyst, [22]

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Okay. I guess, you're not that busy today on the queue. I have some questions actually around your Clothing & Home. So regarding the gross margin, your actual performance and then your guidance change for the year. Why were your sourcing costs higher in the first half?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [23]

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So mostly to do with inflationary pressures that we saw, a good example of that would be labor cost in Bangladesh. I mean, you could argue, I'm not getting into political territory here, but probably not a bad thing that there's some kind of labor, sort of wage inflation in Bangladesh, and we are affected by that. So some labor, some raw material cost increases as well. And the combination of those, in the past, we've been through quite a few years, really a significant extracting significant benefits as we got more efficient and bought better. We've largely driven those out, and we just happen to, in the first half, to have some inflationary pressures, as I described.

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Rebecca Clements;Fidelity International;Analyst, [24]

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Okay. And then in your guidance change for the full year. How much of that change is driven by expectations of higher promotional levels versus sourcing cost impact?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [25]

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Well, actually, what we're forecasting is an improvement effectively in the year-on-year position in the second half. And there will be some elements of efficiencies that we want to drive out in the second half that we think will improve that position. Also it's around the promotional stance. So we've deliberately shortened sale periods in the first half and deeply discounted to almost, you could say, clear the decks a bit and have a better run at full price sales in the second half, which will help improve that margin position. So given where we traded in the first half of the year to get to between 25 and 75 bps down on the full year, will need to be broadly in line year-on-year in the second half.

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Rebecca Clements;Fidelity International;Analyst, [26]

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Okay. Do you feel -- I mean, I guess, that is your update as of today. But given some of the commentary out of the BRC, et cetera, that the promotional environment, which is already quite intense. It sounds like it's been worsening. So is there -- I mean, are you actually seeing that the promotional environment is significantly worse than, say, a year ago or 2 years ago? Or would you say it's kind of par for the course?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [27]

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No, I think it's similar. I'm not detecting really material shifts. Bear in mind, what I just said about our own sales planning was entirely our own internal call, so -- and that's not really a market-based reaction, that's actually the leadership of that business, saying, you know what, we're going to run -- put less stock into sale, run it shorter, deeper discounts to get it in and out quicker so that we have longer periods of time in store, where we're just selling our core products at full price. And although it's painful in the short run, and you've seen some of that pain in the margin result in the first half, you get the upside when you have a stretch of clear full price sales, which actually October was one of those. The market was better. We've talked about that. We were running a Friends & Family promotion, but weren't doing a sales period, and you had higher full price sales year-on-year, which obviously is at a better margin.

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Rebecca Clements;Fidelity International;Analyst, [28]

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Okay. All right, fair enough. I guess, we hope that the rest of the quarter is like that, and it isn't just limited to October.

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [29]

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Yes. And time will tell too and I mean, I think, Steve, the CEO said on the call this morning and then in the presentations, what was that phrase? One swallow doesn't make a summer. One of those lines, although renewals haven't been much.

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Rebecca Clements;Fidelity International;Analyst, [30]

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Yes, that was a Steve I think, yes.

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [31]

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And, it's 4 weeks, it's not the whole year. So he'll be back out in January, and I'm sure he'll have -- he'll be updating then.

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Rebecca Clements;Fidelity International;Analyst, [32]

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Okay. And then my last question is just housekeeping. The currency swap that you referenced is having a positive impact. Was that -- what was that related to? Was that related to your debt? Or is that an operational hedge?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [33]

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It was related to the debt. So we've got a couple of swaps out from a very long-dated U.S. bill of USD 300 million bonds that matures in God knows, 2030, something, ['37]. And actually, it is a real technicality where the margins on those a year or so ago slightly changed, and that created some volatility in the swaps, which we've seen an upside from in this half.

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Rebecca Clements;Fidelity International;Analyst, [34]

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Okay. But that's a paper. That's just an accounting...

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Joanna Hawkes, Marks and Spencer Group plc - Group Treasurer [35]

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It would've been impacted by IFRS 9, and it was a charged before it's unwound as a result of the exchange rate, but it's not really -- it's not cash. No, it's just accounting issue that -- yes.

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [36]

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Thank you, Rebecca. It felt like we might not have many more questions because the queue was so short, but.

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Operator [37]

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We do have a final question from Vicki Gedge with PIMCO.

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Vicki Gedge;PIMCO;Senior Vice President, [38]

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I'm sorry, I turned the call a little late, so apologies if you already talked about this. But I just wondered on the CapEx split for the full year, you reduced guidance. Could you just explain the moving parts, why the guidance has come down? And if that's sort of an ongoing run rate? Or is that timing for this year?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [39]

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Yes. No, more in the sort of timing camp because I think currently, we're at that lower level of CapEx. So we will, of course, only invest where we see great returns, and it's the right time to do that. And we've guided in the past that there would be some modest increase in CapEx, but we're not seeing it now in this year. And so we've chosen to take the guidance down because that's what we think is going to happen, obviously. It's GBP 300 million to GBP 350 million. So yes, the cash, by the way, will be, I think, nearer the bottom end of that range and the additions, which is what we're guiding on. But yes, I mean, for example, on renewal stores, we're trialing a couple of stores. When we prove they've worked, and we've reengineered them to be very efficient, no doubt there will be a rollout program of that initiative with returns, and that will result in a bit of a higher CapEx number. But we're just not ready to do it until we finish the trial.

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Vicki Gedge;PIMCO;Senior Vice President, [40]

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Okay, that's helpful. And then just a couple more. So on Christmas trading you referenced there would be an update. I think you had -- the group had taken the decision to stop quarterly trading updates. But can you confirm there will be a trading update after Christmas?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [41]

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Yes, I think the plan is to do, one, certainly, if it follows pattern of previous years to do a Christmas trading update in maybe the second week of January, something around then. Ninth, something so -- is the current state. And so that's what will happen. It will be a call. It won't be a big presentation. Yes, I know it'll be -- yes, so that will be -- October is certain, yes.

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Vicki Gedge;PIMCO;Senior Vice President, [42]

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Perfect. And then just on following up on Lisa's question on the rating agencies. I mean, clearly, there's a lot going on with the transformation and the pace has kind of increased, if anything, in the recent months, it sounds like. But what does the group see is -- are there any Plan Bs to defend the IG rating? I mean you've already cut the dividend and you have the rights to issue to fund Ocado, but is the Board prepared to cut the dividend further, if needed?

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [43]

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Well, I'm certainly not in my position, and on this call, going to change the dividend policy. No, I think dividend policy remains under review, of course, by the Board in any given sort of period. No. I mean, I think the point around the ratings is that you need to transform the business. And when we can demonstrate not just in Food, but also in Clothing & Home that we're getting it back into growth and then into profitable growth, then that will sort out the rating, if you like. And I think that we've -- where we've had options to go one route or another in terms of debt or if you create sort of equity friendly. We did choose, in the case of Ocado to go that route. And I think that was the right answer.

But the Board will obviously have to take a decision. The overall policy to reemphasize is that we would keep -- retain a capital structure that's kind of commensurate with the rating, an investment-grade rating. But of course, at the end of the day, the rating agencies, even if we do that, might choose to do something.

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Operator [44]

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(Operator Instructions)

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Humphrey Singer, Marks and Spencer Group plc - CFO & Executive Director [45]

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I think we've probably reached the end of the -- we've drained the swamp of questions. But obviously, we're available on the -- offline, if needed, for any follow-up questions. Thank you very much for your time. Talk again soon. Cheers. Bye.

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Operator [46]

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Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.