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M&S share price rises despite 63% fall in profits

If investors have learned one thing about Marks & Spencer (Frankfurt: 534418 - news) in recent years, it is that the company is a past master at managing expectations.

That is why the shares have rallied healthily today in spite of a near-64% drop in full year pre-tax profits.

That is because the underlying full year outcome, of £613.8m, was substantially ahead of the £593m or so that had been anticipated by the company's legions of followers in the Square Mile.

As for the headline pre-tax profit figure, of £176.4m, that was explained away by a tsunami of one-off factors, including changes to pay and pensions, store closures both at home and overseas, a bill for yet more past PPI mis-selling at M&S Bank and restructuring costs at the company's head office, where Steve Rowe, the chief executive, has been slimming down the ranks of top management.

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The bigger picture is that Mr Rowe and his colleagues appear to be delivering on the promises they set out a year ago, which was to wean the group's clothing and home division off promotions and discounts, while continuing to grow its well-regarded food business.

In food, while profit margins have slipped, overall sales rose as M&S opened another 68 of its popular Simply Food outlets.

Like-for-like sales, which strip out the impact of new store openings and refurbishments of existing stores, were down slightly but most of that can be explained by the later timing of Easter this year.

Crucially, M&S has seen its share of the UK food market rise to 4.5%, up from 4.3%. There is little wrong with this part of the business.

As ever, the bigger question marks are over clothing and home, a division that saw sales fall by £250m in the three years prior to Mr Rowe taking up the role in April last year.

These were down by 2.8% during the year and by 3.4% on a like-for-like basis.

That looks disappointing - although Mr Rowe can point to the fact that, thanks to better buying and cutting back on discounts, as he promised a year ago, profit margins in the division are rising, with more items being sold at full price.

There were three fewer clearance sales this year than last and those hoping to capitalise on the next one will have to wait until July. That is a major improvement but something that, in view of the fact that two in five items were previously being sold at a discount, was absolutely essential.

Meanwhile, as Mr Rowe pledged a year ago, the most popular lines were more readily available and did not sell out as they have done in previous years.

In a clothing market that remains challenging, to say the least, M&S appears to be holding onto its market share. That is no mean feat, as anyone who has looked at the performance of rival Next (Frankfurt: 779551 - news) will know.

The entire sector is trying to run up a down escalator, and that challenge may get harder still once Amazon's fashion arm gains traction.

M&S's online arm is currently the second largest online fashion retailer in the UK, and growing strongly, but that momentum will need to be kept up.

M&S is in a strong position in some lines - for example, it has almost 35% of the UK market in bras - but those strengths could easily become weaknesses, should Amazon choose to target 'basics'.

What is not happening just yet, though, is a return to growth in clothing and home. That will almost certainly come in the current trading quarter, the first of the new financial year, due to comparisons with a particularly weak quarter in the same period last year.

But growing clothing and home sales across the year as a whole will remain the key barometer of progress - not least because, while it accounts for only 35% of sales, clothing and home accounts for half of operating profits.

In the meantime, the balance sheet is being carefully managed, with debt continuing to come down, while finance director Helen Weir continues to maintain an iron grip on spending.

Capital (Other OTC: CGHC - news) expenditure, even ignoring the one-off costs last year of opening a new warehouse in Bradford, was down by £137.7m year-on-year.

Investing in IT remains a huge cost, but M&S is not splurging on store upgrades as it once did, while the bulk of the heavy lifting in online appears to have been done.

Broadly speaking, then, the challenge for M&S remains the same as it did a year ago - to carry on growing its much-admired food offering while, at the same time, returning to profitable growth in clothing and home.

This is all in an environment in which it needs to further reduce the amount of store space devoted to that category and at a time when shoppers are losing confidence, and rising inflation is eating away at disposable income.

It won't be easy.