Stockwatch: what lessons can BT teach us about M&S?

Both stocks have fallen to historic lows, but their share price will respond well to good news stories – perhaps at the Christmas update.

Is there a parallel between BT (LSE:BT.A), which I examined in my last column, and Marks & Spencer (LSE:MKS), another big company unfashionable with investors?

Both stocks have fallen to historic lows, which you can interpret as a discount to net asset value, hence their market price is sensitive to any improvement in the narrative.  

There is also an overhang of jaundiced comment. M&S has just declared its first-half interim results, and I noted a familiar riposte: it just does not have its act together for clothing. 

There is some truth to this, given today’s market is more about leisure clothing than the formal/occasion-wear that M&S tends to be associated with. 

Yet the stock has risen nearly 5% to 96p despite media headlines of its ‘first loss in 94 years’. Investors are looking past severe Covid-19 disruption in two of the six months to 26 September to better prospects, as the food side’s tie-up with Ocado (LSE:OCDO) kicks in.  

Lockdown 2.0 may mean more online food orders

M&S’s risk/reward profile is unexciting yet attractive: last May at 88p I rated it a ‘buy’, given a 30% discount to net tangible assets plus the medium-term prospect of Ocado substituting its Waitrose partnership with M&S. 

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The current 96p price represents a 21% discount to net tangible assets of 121p a share as of September. Yes, that value has reduced, but the discount remains high unless you critique retail assets as going the way of the dinosaurs. 

The latest lockdown emphasises the Ocado tie-up as timely and with potential to normalise  consumers ordering a wide range of M&S food online. 

Balance sheet and story are similar to BT 

The read-across to BT is that despite its mixed-up balance sheet of intangibles, debt and a pension deficit, you can identify a notional sense of asset value from the Openreach national telecoms network. Its stock has fallen from 470p to about 100p and interesting sum-of-parts estimates emerge with occasional bid speculation. 

BT’s narrative also has something new by way of fibre-to-the-premises’ upgrades boosting revenue, and the board entertains the prospect of a progressive dividend policy from 7.7p in the March 2022 year. 

M&S has likewise axed its payout for now, and if forecasts are fair then about 5p can be expected in the year to March 2022. That is way down on nearly 18p a few years ago, yet the table shows very strong historic cash flow numbers. If management can transition more business online then a payout nearer 10p might be possible.

A sceptic might say this required transition online illustrates how £5.3 billion property/plant/equipment – in context of £2.7 billion net assets – is ‘yesteryear’ value. 

Big retail assets will increasingly become redundant and are harder to re-adapt than town-centre offices – say into residential flats. 

I go along with this to some extent, but people’s hunter-gatherer instincts will eventually spur the need to get out the house once Covid-19 is tempered. There is also the tedium of returning clothes bought online that do not fit. 

Moreover, the M&S estate involves substantial leasehold space: during the six-month period 11 leases were re-set with an average 34% rent reduction. Three new full stores were launched during the interim period, five Simply Food stores opened and 10 stores closed.  Adaption to a new era looks well underway.

Big statutory interim loss despite government support 

It compares with a like-for-like £150 million but includes £70 million adjusting items, £10 million of which related to Covid-19, such as wages for furloughed staff. Yet it was mitigated by £98 million furlough payments and £84 million business rates relief. 

Such extent of ongoing public support - furlough extended generally to next March - begs the question why retailers should pay dividends until taxpayers are compensated, though enough may get away with it.  

Normalised operating profit plunged 77% to £62 million, on revenue down 16% to £4.1 billion. Not surprisingly the headline adjusted operating profit from food was up 19% and Ocado-related revenue up 48%.  

The Ocado Retail contribution needs better clarity: it can come across as a joint venture with each side owning 50%, but exclusive Waitrose sales only ended on 1 September, hence ‘up 48%’ makes no sense. 

Expect dramatic percentages from base zero, however none yet exists for comparison.

Encouragingly, growth is constrained by capacity limits at fulfilment centres, however “investment is in place to drive substantial growth with 40% additional capacity by autumn 2021 and further growth thereafter”.

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UK food sales constituted 69% of group interim revenue, although a year before it was 59% versus 32% for UK clothing/home with international sales making up the rest.  

Clothing/home used to enjoy a 7% operating margin but its interim operating profit has swung from £110 million to a £108 million loss.

Food was on a 3.2% margin a year ago, that has edged up to 3.9% with a £110 million contribution this time.  

So a recovery to anything like M&S’s previous financial form requires turnaround on the clothing/home side – hence the question arises whether its marketing is sufficiently well-attuned. 

Is the M&S formal/occasion-wear bias plain wrong?

A dilemma for these pandemic times is the belief that M&S doesn’t really do casual clothes.

Who is going to spend money replacing garb for the office when spending more time in jeans and sweaters in front of a PC? 

Formal occasions will be off-limits until 2021 at best. Management believes demand for more formal clothes will return, although I am with critics who say the leisure offering needs to improve.  

Meanwhile, Boohoo (LSE:BOO) brushed aside the April/May lockdown as a highly adept online fashion retailer, and is expected to post earnings per share (EPS) up at least 50% in its year to end-February 2021. 

M&S does appear to be making great efforts towards “a fully integrated online, digital and data division, as a step change, with a three-year target to achieve an online sales mix of at least 40%.   

Upshot for free cash flow, hence dividend prospects 

A circa 5p a share dividend – the consensus projection for the 2022 year - would cost around £98 million. It compares with £191 million shown in cash flow statements as going out during the March 2019 year and £115 million in that first half.  

It also compares the latest interims showing £351 million net cash generated from operations, £120 million applied for investment and £172 million in support of financing. So, there was no leeway for a payout. Also, the closing net cash position fell 28% year-on-year. 

The £4.1 billion total debt generated £107 million finance costs, mitigated by £28 million finance income, hence debt servicing needs also weigh against restoring the dividend in the near-term. 

By contrast, BT reckons the fruits of its investment (and I should say, respecting next April’s price increases across customer accounts) make it confident of resuming payouts – it would appear sooner than M&S. 

Both M&S and BT are classic ‘big unpopular stocks’

If Benjamin Graham’s ‘The Intelligent Investor’ remains apposite, this is a stock category that could be a cornerstone of investment value. 

Such companies are very well-established, may be going through short to medium-term issues, but in principle are capable of re-inventing themselves.

The most outstanding example was International Business Machines (NYSE:IBM) in the 1990s. Stock upside is enhanced by jaundiced sentiment – reflected in a discount to net asset value – which accentuates any uptrend once underway. The mood swing may be more clearly defined. 

I would regard M&S as a long haul job. Its management is effectively turning a super-tanker.

Yet it is possible. This set of interims make a trough for clothing/home, and the Ocado partnership evolves well. 

Much therefore depends on the tenor of updates and cautious investors will probably wait for the Christmas one. 

But if the group can simply restore EPS for its 2020 year, in 2022, the forward price to earnings ratio is a modest 8x. My broad stance remains: ‘Buy’. 

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