Jeremy Warner's Outlook: Rose defends a grim update from M&S

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Sir Stuart Rose, the newly knighted chief executive of Marks & Spencer, was uncharacteristically tetchy and defensive during his press call yesterday to announce the retailing giant's trading update. Who wouldn't have been after the jaw-dropping 20 per cent collapse in the share price that greeted the news of a 2.2 per cent fall in UK like-for-like sales?

Yesterday's pummelling takes the price back to not much more than the £4 a share of Sir Philip Green's mooted takeover bid three and a half years ago. Little more than six months back, the shares were at an all-time record of £7.50. Whatever Sir Stuart says, psychologically, the market reaction must have been a terrible blow.

It is as if, at a stroke, the entire Stuart Rose turnaround story has been wiped out, returning M&S to the dire straits it was in when Sir Philip made his ultimately unsuccessful takeover assault. Just a few months back, Sir Stuart could have looked forward to setting a retirement date and the applause of a job well done. Now he's got it all to do again.

Sir Stuart was keen to stress that, if he sounded irritated, it wasn't so much the share price reaction that irked him as the stock market's failure to appreciate that, taking into account the consumer downturn, the underlying sales position was actually remarkably good.

M&S has never sold more frocks, overcoats, underpants and shoes than it did during the third quarter to the end of Dec-ember. Volume sales grew at their fastest rate in six years. Unfortunately, it wasn't by enough to counter the intense pricing pressures the company was under across virtually the whole of its clothing range. Prices fell by more than volumes could grow. The consumer got a great deal out of M&S this Christmas, but it was very much at the expense of the private investor.

How did the stock market come to be so wrong-footed? In part it was a failure on the company's side to manage expectations quite as expertly as they perhaps should have been.

To Stuart Rose, it was because investors have been in denial about the true state of the retail economy, preferring to think that things were actually a bit better than business leaders have been letting on. Bumper sales figures from John Lewis, which many people instinctively think of as having the same market positioning as M&S, encouraged the view that M&S would have had a reasonable Christmas.

In fact, John Lewis has a completely different profile, both in terms of its sales mix, its geographical distribution and its demographic. What's more, to achieve its sales growth, John Lewis engaged in steep price discounting, particularly on electricals. We don't yet know what that has done to the bottom line.

Whatever the reasons for the mismatch in expectations, the key question for investors in M&S going forward is how much of this disappointment is down to the depressed state of the consumer market and how much is self-inflicted.

This remains a quite difficult question to answer. Sir Stuart himself says it is 70-80 per cent the market, pointing to a distinct weakening in trading conditions, particularly outside London and the South-east, during November and December.

It is also true that, as the market leader by a long way in clothes retailing, M&S is bound to find itself in the vanguard of any slowdown in consumer spending. Even in a recession, supermarkets tend to do relatively well because, whatever else consumers are forced to give up, they have to eat. Asda said yesterday that it had had its best Christmas ever. Yet many clothing purchases are discretionary, and are therefore the first to feel the cold winds of consumer belt-tightening.

Up to a point, then, Sir Stuart is right to insist it was the market what done it. Even so, that hasn't stopped questions being asked about whether he's getting the sales mix and pricing proposition entirely right. Those that claim the attempt to appeal across the demographic, from the poorest to the richest, is the wrong approach for a clothing retailer and only serves to confuse the consumer have been given plenty of ammunition in these results.

All that said, the stock market has almost certainly over-reacted to what was announced yesterday. M&S remains an extraordinarily powerful, financially sound, brand which despite the sales shortfall should still be capable of making profits in excess of £1bn this financial year. It is, of course, what happens next year as the consumer slowdown gains momentum that the analysts worry about most.

Sir Stuart says markets are finally waking up to the fact that the UK economy has got a cold. But it is not yet pneumonia. By purchasing £1m worth of shares yesterday, Sir Stuart is signalling that not even he thinks it is going to get that bad. We'll see.

BA first on 'open skies' flights

Having so fiercely resisted the Open Skies treaty agreed last year between the European Union and the US, British Airways has ironically become the first flag carrier fully to take advantage of the limited liberalisation it allows.

Plans announced yesterday to devote one of the company's 757s to flying daily between New York and either Brussels or Paris are the only committed instance so far, other than Air France's proposed Heathrow/LA flight, of a transatlantic route where the aircraft neither takes off nor lands in the flag carrier's own home market. BA can claim to have got there first because it filed for its permissions before Air France.

Small beginnings, perhaps, but BA plans to put a further five of its 757s on to routes between the US and mainland Europe by the end of next year. BA's already strong brand presence in the US makes it a more formidable competitor to rival European flag carriers on their home turf than they are likely to be to BA if and when they start flying from Britain to the US.

BA was widely accused of merely defending its monopolistic grip on the lucrative Heathrow franchise when it opposed the Open Skies deal, and no doubt there was an element of that. But the main objection was the new treaty didn't go far enough rather than to the concept of liberalisation per se. No business, even if it is an airline, can realistically expect to sustain cartel-like arrangements in this day and age.

The complaint was rather that the treaty was unduly favourable to the US, and even on this front the EU was eventually prevailed upon to say it would scrap the deal if Washington hasn't by 2010 agreed to a second phase allowing European and US airlines to buy each other and European ones to run US domestic services. This is the holy grail of full deregulation that BA had been seeking.

For the time being, it must make do with the watered-down version, from which it any case seems destined to win more than it loses. At a press party yesterday, Willie Walsh, the chief executive, said this would be a year of big challenges for BA, not least because of the company's move to Terminal Five at Heathrow in a couple of months' time.

Yet perhaps the bigger challenge is going to be that of a pronounced, post-credit crunch, business downturn. For the time being, there is very little evidence of it at BA. There's been some fall-off in short-haul premium traffic, but no sign of a downturn whatsoever on long haul, even on transatlantic routes where you would expect the investment banking meltdown to be already hitting premium traffic badly.

Meanwhile, the Asian routes are going gangbusters, particularly India, where since deregulation in 2004 BA has expanded its number of flights from 19 to 55 a week. On many of these flights, it is impossible to find a spare seat. In theory, this should make BA better equipped to withstand a US recession than it was last time around in 2001/2. Today, the airline can more easily shift capacity elsewhere if the going gets tough on the transatlantic routes. Yet it may be a year or two before we know for sure whether the practice matches the theory.