Nick Bubb’s verdict: John Lewis Partnership is still under pressure

Back in March the group cut its annual staff bonus to just 6% to create a more sustainable base.

Given the pressures on the business and the cautious outlook that came with today’s interims, it looks like a prudent move.

Ironically, JLP’s annual profits for last year were rather better than expected, thanks to some welcome signs of greater cost control in both Waitrose and the John Lewis businesses, but in March management were well aware that this would be another tough year on the high street and that restructuring costs would be a burden.

“John Lewis is showing some signs of better form in recent weeks, thanks to the helpfully autumnal weather conditions”

Today, the partnership reported a 53% crash in pre-tax profits, brought down by an exceptional charge of £56m − mainly for restructuring and redundancy costs − which comes on top of the £25m of store asset write-downs at Waitrose incurred a year ago.

JLP said that the exceptional costs this year refer to branch, distribution and retail operations, “as well as functional restructurings in finance, personnel and IT, as we move from divisional to partnership functions”.

Future profits

Fortunately, the restructuring activity this year has been “front-end loaded” and the second half exceptional charges will be less, but JLP has also warned that profits will be hit by higher pension accounting charges in the second half as a result of low market interest rates.

The likely outcome for full-year profits will become much clearer after Christmas, with the key final quarter still to come and trends in the two divisions rather mixed.

Waitrose got off to a rather difficult start in the second half, but John Lewis is showing some signs of better form in recent weeks, thanks to the helpfully autumnal weather conditions.

In the first half, Waitrose eeked out a modest 0.7% like-for-like sales growth and controlled its branch and central costs well, but all the benefit here was eaten up by pressure on gross margins.

The upmarket grocer’s managing director Rob Collins said that product cost price inflation was 4.5% – because of the weakness of sterling – but selling price inflation was only 1.5%.

“Waitrose is an expensive place to shop, notwithstanding its focus on food provenance and quality”

The result was that first-half underlying operating profits at Waitrose fell 17%, to £101m.

Waitrose is an expensive place to shop, notwithstanding its focus on food provenance and quality, and management were doubtless conscious that there is a limit to what increasingly cash-strapped and uncertain customers can afford as the relentless advance of the discounters increases the availability of cheaper grocery shopping options.

Over at John Lewis, like-for-like sales growth was a mere 0.1% in the first half, but underlying operating profits of £40m recovered a little, in the absence of last year’s transitional costs.

John Lewis boss Paula Nickolds is focused on differentiating the brand and growing market share, so the new-look store opening in Oxford on October 24 will be a good test of the strength of the business.

Expensive cost base

Nevertheless, the structural pressures on John Lewis continue and although online sales continued to grow nicely in the first half, climbing around 11%, like-for-like sales look to have fallen about 4%, on top of a 2.5% decline in the first half of last year.

Interestingly, Next today set out a very detailed analysis in its interim results of how a worst case 6% annual decline in like-for-likes would impact long-term profitability and cash flow.

Next was able to conclude that its stores would be able to withstand such an extreme fall in like-for-like sales over the next 10 years because “firstly, we have a store portfolio that is extremely profitable with an average net branch contribution of more than 20%. Secondly, we have a relatively flexible store portfolio with an average lease commitment of seven years”.

Unfortunately, John Lewis is nowhere near as profitable as Next and it has far higher fixed operating costs, although it does boast more freehold and long leasehold property in its store portfolio.

Ultimately, the brutal honesty that Next have brought to bear on the long-term outlook for its store profitability will have to be applied to the John Lewis portfolio.

And the outlook for the JLP bonus and its profits in the long term will be as much determined by the ability of both Waitrose and John Lewis to manage their cost bases and drive up productivity, as it will be by top-line sales.