Interactive Investor

Stockwatch: can Marks & Spencer keep its strong run going?

24th August 2021 11:03

Edmond Jackson from interactive investor

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Our equities expert considers whether one of the biggest names on Britain’s high streets can keep delivering the goods for investors.

Does recent progress made by Marks & Spencer (LSE:MKS) chiefly reflect its transformation plan – or mainly buoyant consumer spending?

It is a key question after the stock has had a good run in the last year or so; currently up 90% to 167p after I argued a “buy” case at 88p in May 2020.  

The rationale was a 30% discount to net tangible assets of 137p a share, based on the 28 September 2019 interim balance sheet, hence the stock was likely to mean-revert if trading updates could improve.

Last April’s balance sheet showed net assets of 117p a share, or 105p on a net tangible basis, hence earnings/dividends recovery are now more in focus. 

Prospective price/earnings could be as low as 5x 

If the group achieves consensus for £263 million net profit in the current financial year to 3 April 2022, then £320 million in the April 2023 year, it implies earnings per share (EPS) of 13.2p rising to 15.9p – hence a prospective price/earnings (PE) multiple of 12.7x falling to 10.5x.  

That is modest if M&S can recover normalised EPS to pre-pandemic levels around 37p, which ought to be feasible at some point given management’s professed satisfaction with a transformation plan.

Food also clothing and home product ranges have expanded, there is growing digital capability, streamlined stores, better supply chains and reduced costs. 

In which case, the medium-term forward PE is just mid-single digits and a multiple more like 20x the current outlook would be fair – suggesting a price target around 300p, the stock could continue creeping up towards unless the macro environment worsens. 

Much still seems to hinge on continued success with the UK Covid vaccination programme enabling more consumer activity, and this being sustained through autumn/winter, than a return to tough controls like in Australia and New Zealand currently. 

Ocado relationship and progress with clothes have been a crux 

I had thought a new distribution partnership with Ocado (LSE:OCDO), where M&S replaced Waitrose, could provide a sustainable boost – past the recent buoyant period supermarkets have enjoyed, due to Covid restrictions on restaurants and pubs.

By last May, M&S items constituted over 25% of the Ocado basket, out-performing Waitrose, and the aim is to grow capacity by around 50% in the next 18 months. 

Unless clothes and home products prove a complete marketing fail therefore, a re-invigorated M&S ought to be capable of outperforming its pre-Covid guise.

The clothing side has been in a somewhat invidious position given a fairly strong reputation for formal wear, demand for which was hit hard by Covid and which management thought would return.

However, marketers have long felt M&S clothes needed refreshing and I suggested in May 2020 that “if the clothes marketing plan is finally credible, this could be the stock’s trough”. 

Three years of change brought forward to one 

The stock bumped along until the 4 November interim results proclaimed “robust performance in unprecedented times, as transformation accelerates” despite group revenue down 16% and operating profit by 77%.

Management proclaimed it had become a leaner, faster and more digital business in just a year, and this did coincide with the stock then rising from 96p to 140p. However, many stocks were benefiting at the time from a major positive surprise regarding the efficacy of Covid vaccines. 

After hitting 170p last May, the stock drifted near to 130p by mid-July – for which there was no specific trigger, but I imagine enough holders were edgy to lock in gains after a near-doubling from the low. 

An 18 August update then revealed total revenue down 39% over 13 weeks with varied performance across the stores estate as it re-opened with Covid restrictions easing. However, this reflected town centres and shopping centres still heavily impacted by social distancing.

More positively, over eight weeks the portion of online sales had grown to 41% of total clothing and home. Overall, it was a mixed update i.e. difficult to spur conviction in the stock.  

A more definitive response to the 20 August update 

The price rose 14% to 163p last Friday in response to robust performance for the 19 weeks to 14 August; and early this week has seen further strength to 167p. 

Food is performing well, up nearly 11% year-on-year and 10% on the 2019/2020 financial year, pre-Covid.

Key food items also retail park locations have traded strongly, but hospitality/franchise sales such as coffee shops remain below 2019-20 levels due to lower footfall in stores and a slow return to more normal work patterns.  

Clothing sales have nearly doubled on the year and are down just 3% on 2019-20. It does sound finally as if M&S is achieving marketing traction – with more focused ranges, fewer promotions and a substantially smaller summer sale.

The shift online continues: clothing and home online sales up 22% on 2019-20 and comprising 35% of total sales, while store sales are down nearly 20% on 2019-20. Retail parks outperformed however.  

International sales are also recovering well, up 40% on last year albeit 5% down on 2019/20 as a lockdown in India and Brexit issues with selling food into Ireland and France, took some toll. Global online sales are also up 40% and have more than doubled on 2019/20.  

Cost reduction initiatives are mitigating cost inflation and disruption in the supply chain, also higher colleague absence. 

Marks & Spencer - financial summary
Year end 3 April

  2016 2017 2018 2019 2020 2021
Turnover (£ million) 10,555 10,622 10,698 10,377 10,182 9,167
Operating margin (%) 5.5 2.4 1.5 2.9 2.5 -0.4
Operating profit (£m) 584 253 157 298 255 -37.5
Net profit (£m) 407 117 25.7 41.7 23.7 -198.0
Reported EPS (p) 23.7 6.9 1.5 2.5 1.2 -10.1
Normalised EPS (p) 37.4 36.1 36.8 37.0 22.1 4.5
Earnings per share growth (%) 16.2 -3.4 1.9 0.4 -40.3 -79.8
Price/earnings multiple (x)           36.5
Return on capital (%) 9.2 4.3 2.7 4.6 3.1 -0.6
Operating cashflow/share (p) 70.6 62.6 49.9 73.1 50.1 44.6
Capex/share (p) 32.0 24.1 20.5 18.4 17.2 10.6
Free cashflow/share (p) 38.5 38.6 29.4 54.8 32.8 34.0
Dividend per share (p) 17.9 17.9 17.9 13.6 3.9 0.0
Covered by earnings (x) 1.3 0.4 0.1 0.2 0.3 0.0
Cash (£m) 267 483 221 452 266 693
Net debt (£m) 1,806 1,747 1,575 3,802 3,813 3,355
Net assets/share (p) 203 186 174 152 190 117

Source: historic company REFS and company accounts

Profit guidance is raised to the upper end of £300-350m range 

This is made with the caveat of no further Covid-related restrictions on trading, but the market is justifiably interpreting it well because it could be the start of a trend –as the transformation plan henceforth bears fruit. 

Yes, there is uncertainty as to where the balance of consumer spending settles. To what extent will the winding down of furlough payments affect overall disposable income?

Or is a majority of middle-class households that typify M&S’s customer base sufficiently affluent – having saved in the last year or so, from not eating out or spending on foreign travel? 

Official data also released last Friday showed UK retail sales eased nearly 3% from June to July, though is quite a snapshot. 

Remaining shtum on dividend restoration 

M&S is unlike BT’s re-rating where specific guidance was given to expect a generous dividend this financial year.

There has been nothing in last May’s results or the latest update to back up market expectations for a 0.25p a share dividend in respect of the current year and 6.5p for 2022/23, the latter to cost £127 million.

This does, however, imply a meaningful, near 4% prospective yield around the current stock price, and is supported by last April’s balance sheet showing £674 million cash, up from £254 million.

Moreover, the table shows an historic profile of very strong free cash flow per share, which ought to enable more significant recovery in pay-outs – the M&S total dividend used to be near 18p implying a near 11% yield at current market price.  

I think the potential financial benefits here – both for earnings and dividends – make M&S a strong hold and potential “buy” on weakness unless related to more Covid restrictions. Hold. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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