Marks and Spencer (LON:MKS): Is there a level at which value can be had?

The news headlines this morning were dominated with Marks and Spencer’s results. Only the previous day, they announced the closure of 100 of their stores (some of which have happened already), to be followed by their results today. The timing of this was odd, considering that these two announcements could really have been made together. However, despite adverse coverage by the BBC, the anticipated bloodbath did not occur and in fact at the time of writing, the share price trades slightly up.

That said, these are only small crumbs of comfort, as the last couple of years have been a very rough ride for shareholders, who have suffered rather large declines in their investments:

And perhaps rather ominously, shorts are gathering on the horizon: a massive 12% of shares are short, which places M&S among the likes of the now-defunct Carillion and Debenhams. It’s clear that for some people at least, they fear that worse is to come for this very British institution.

My opinions on this are rather mixed. The news that the shares increased in price today was more to do that profits in real terms was not the 60+% crash that many news outlets are reporting. The real reasons are included almost at the very top of the report:

 Significant adjusting items of £514.1m including £321.1m for our UK store estate closure programme. Cash costs of transformation remain in line with plan.

This is a lot of money to adjust for the closure of 100 stores and I certainly believe that the cuts won’t end there. This ‘adjusting item’ could be a feature for quite a few years to come. Much like Debenhams, M&S is lumbered with some colossal stores, and there seems to be very little importance nowadays on having a massive store. I am sure that there are plenty more marginal locations.

It also is the case that M&S is in a gradual state of drift. Most parts of its business are being eaten away by competition. Clothing is heavily at risk in what is a more fragmented and competitive market. It would be fair to say that M&S have not chosen to compete in the younger markets, which are dominated by the likes of Primark, H&M, Uniqlo and the like, but the more mature markets could be seen as ripe ground for new entrants. Bonmarche and Sosandar in particular making plays for the important ‘mature’ female segment. The new chief Archie Norman put it pretty well when he said (in not so many words) that they needed to modernise or die.

Having said that, M&S are not the dinosaur that Debenhams are quite yet. They are quite similar in that profits are in decline due to competition and
changing consumer tastes, and a debt level that looks uncomfortable on the back of decreased profitability. But M&S has some aspects which do deliver - such as the food halls side.

Clearly by recognising a problem now, there is still time for things to be done. But the counter argument against that is that even with the store closures, M&S may already be looking at market saturation, at least in the UK. With 1,025 stores already in the UK it seems that a reduction in these is more likely in future. And with cost of closures being so high (around £3m/store in the UK, perhaps treble this overseas), change isn’t going to be quick.

Some possible strategies for the future as I see it:

Increased roll-out of food: The food side of the business has been a success on the scale that people don’t realise: the company takes more money from this side of the business than the rest combined – very impressive considering that even the larger food halls fall some way short of being a proper substitute for a supermarket for most people ,and that most products command big price premiums over others. A bigger variety of size of stand-alone shops could be looked at – virtually any location with a good people flow should work well. 

International improvements: Many stores outside of the UK are run on a franchise basis, but the general feeling is that of inconsistency, with ‘old’ liveries being used. The numbers for this also are not as impressive, understandable that very few of the stores feature much of an equivalent of the food hall. ‘Britishness’ is a decent enough marketing concept, as well as a latent market of ex-pats wanting British staples. Marrying the two could be a good concept although it would be a expensive option.

Changing the clothes offering: A re-brand of the clothes offering would be fairly simple and cheap. M&S could look at aspects of those competitors who have muscled in on their business and make plays to regain lost market share. Some of the bigger stores have much room for the ‘store-within a store’ concept that many others are looking at now.

Expand into new areas altogether: M&S carries a strong brand name which could be leveraged to go into other areas. although quite what this would be is unknown, and they have tried other lines such as electronics without success.

Whether these shares represent a good investment case for me is unclear. Their profit projections for the next couple of years seem to be at risk to me with continued loss of market share in clothing and the prospect of further expensive store closures resulting in additional profit write-downs. They pay a good dividend – over 6% now at current prices, but this seems to me to be not sustainable: in recent years dividend cover has been less than 1. Cutting the dividend would provide some much needed cash, but with such a popular share the market reaction may be fairly furious.

I actually believe that in the short-term the shares have a bit further to fall. The P/E ratio of 10.8 is deserved at this moment in time, as whether the company can deliver the change it wants remains under question. But if they can successfully do it, the turnaround could be very strong here.

 

Pure Passive Investor. Always looking for ways to make money (but not myself) work harder.

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