The 3 Biggest Risks Facing Marks & Spencer

LONDON -- Iconic retailer Marks & Spencer  (LSE: MKS  ) needs little introduction. With its 730 or so British stores giving it a presence in pretty much every U.K. High Street and out-of-town shopping mall, it's a stock that has long proved popular with private investors. A 6.3 billion pound FTSE 100 constituent, last year the company earned a pre-tax profit of 658 million pounds on revenue of 9.9 billion pounds.

Today, with its shares changing hands at 392 pence, the company is rated on a prospective price-to-earnings ratio of 11, and offers income investors a tempting forecast dividend yield of 4.7%.

But how safe is that share price? And -- of vital importance to income investors -- how safe is that dividend? In short, how could an investment in Marks & Spencer adversely impact investors' wealth?

In this series, I set out to answer just these questions. My starting point: Marks & Spencer's latest annual report, where the company's directors are obliged to address the issue of risk.

Risk management
One immediate thing that I'm looking for is an acknowledgement that risks do exist, and that they need managing.

The good news? As you'd expect from a business of Marks & Spencer's size and caliber, the company has in place a risk management policy, a system of regular reviews, and a number of high-level committees tasked with monitoring the risks that the business has identified. Indeed, of the various companies that I've reviewed in this series, Marks & Spencer has outlined one of the best risk mitigation strategies that I've seen.

But what, precisely, are those risks that the company faces?

Read the small print, and Marks & Spencer identifies no fewer than 16 risks as having a significant prospective impact on the company's financial performance. They range from food safety risks to reputational risk, and from IT failure to a misreading of the runes of fashion.

So let's take a look at three of the biggest.

The economy
Marks & Spencer has a five-year plan: Plan A, comprising a hundred key commitments, largely revolving around corporate and social responsibility. The subtext, of course, is that Plan A will further endear the store chain to affluent shoppers with a conscience. The problem? Although Marks & Spencer has once again set out to develop an international presence, it's essentially a business that is largely dependent on the British consumer for sales: just 11% of revenue comes from overseas consumers.

And fairly obviously, British consumers are having a tough time -- and one where they might be tempted to ditch Marks & Spencer's high-quality, upmarket, socially responsible products for cheaper stuff of less-assured provenance. As the company itself puts it: "[There is a risk that] worsening economic conditions will impact consumer confidence and our ability to achieve the plan."

And it's a risk that Marks & Spencer openly acknowledges, admitting that as consumers' disposable incomes come under pressure from price inflation and government austerity measures, trading conditions continue to remain a challenge for the business.

So what is it doing about it? First, the company is regularly reviewing and monitoring the effectiveness of its pricing and promotional strategies across both its general merchandise and food businesses, and tailoring its consumer offerings where appropriate. And second, it continues to actively manage and minimize costs where appropriate, while regularly reviewing customer feedback and its positioning in the market place.

Will this be enough? Time will tell.

Flawed execution of new selling channels
Famously, Marks & Spencer is a business that didn't accept credit cards until 2001, and also firmly eschewed advertising, even in new overseas markets. Today, the company is intent on becoming a leading international multichannel retailer by 2015, with a major overseas expansion program, new store formats, and a new online platform to replace the one currently managed by Amazon.

Fairly obviously, there's a lot that could go wrong -- particularly given the timescale. Or, as the company itself puts it:

[There is a risk that we might] fail to deliver improvements across our store estate to time, to budget or to the desired quality... [and that] a new online platform with flexibility to support future growth is not delivered by the time our contract with Amazon expires... [and that] a failure to leverage our systems, processes and controls limits the growth of our international business.

In short, execution is everything -- as the company knows too well. In terms of the refreshed store formats, for instance, adherence to program schedules, budget, and quality standards will be key to successful delivery of the next phase of the rollout, as the company readily concedes.

Likewise, Marks & Spencer is working closely with Amazon to ensure a smooth transition onto the new online presence, and in any case has already decided to adopt a phased implementation. Internationally, it acknowledges, the issue isn't just around having systems, policies and managers familiar with the Marks & Spencer "way," but also mundane matters such as supply chain management -- the stores might be thousands of miles away, but the goods still have to reach the shelves.

Loss of engagement with core customers
Who shops at Marks & Spencer? Your mother and my mother, quite simply. Rather like the fabled elephants' graveyard, people seem to get to 55 or so, and suddenly decide that Marks & Spencer is cool and trendy. And, indeed -- by design -- many of the Plan A initiatives are designed to appeal to just that particular demographic.

But supposing Marks & Spencer lost its touch? In the fashion business, it's an obvious risk. And it's happened before: Marks & Spencer posted a billion pound profit in 1997 -- and three years later, watched it slump to 145 million pounds. From being a stalwart of the High Street, Marks & Spencer became a laughingstock, with many of its traditions mocked by newer, hipper stores. As Marks & Spencer notes: "As we seek to enhance the M&S brand and make our sub-brands more distinctive, it is important that we continue to address our core age 55+ customers' specific needs in an increasingly competitive and economically uncertain market."

Certainly, the company is aware of the danger, and reports that it prioritizes a focus on the needs of its core customers, and monitors the customer reaction to product and in‑store experience through focus groups, online reviews, and its in‑house Customer Insight Unit.

Risk vs. reward
Finally, two superstar investors who are well-used to weighing risks are Neil Woodford and Warren Buffett.

On a dividend reinvested basis over the 15 years to Dec. 31, 2011, Neil Woodford delivered a return of 347%, versus the FTSE All‑Share's distinctly more modest 42% performance. Warren Buffett, for his part, has delivered returns of over 20% per annum since 1965, transforming himself into the world's third-wealthiest person.

Each, as it happens, are the subject of two special reports prepared by Motley Fool analysts. And they're yours to freely download, without any obligation.

So click here to download this free special report profiling the investment logic behind eight of Woodford's largest and most successful current picks.

And click here to discover which beaten-down British share Warren Buffett has been buying of late -- and why he bought it, and the price he paid

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