At the Marks and Spencer Group (LSE: MKS) AGM yesterday, the firm’s chief executive Marc Bolland referred to a 20-year history of underinvestment at the store, according to a report in The Guardian.
Bolland, of course, was previously CEO of Wm. Morrison Supermarkets (LSE: MRW), a business that is suffering badly as a result of historic underinvestment in IT and infrastructure — including during the period that Bolland was in charge.
This coincidence prompted me to take a closer look at Marks and Spencer — could the UK’s high-street stalwart be heading for a Morrisons-style decline?
Passive income stocks: our picks
Do you like the idea of dividend income?
The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?
If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…
Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.
What’s more, today we’re giving away one of these stock picks, absolutely free!
Striking similarities
Press coverage might have you think that Morrisons is a basket case, while Marks and Spencer is on the verge of a successful turnaround.
However, I’m not sure that this picture is accurate. I reckon there are some striking similarities in the two firms’ current situations, which suggests that M&S shareholders may have to endure a deeper decline than expected, while Morrisons’ recovery could come sooner than you might think:
| Marks and Spencer | Morrisons | |
| UK like-for-like total sales (Q1) | +0.3% | -7.1% |
| 2009/10 underlying operating margin | 8.6% | 5.3% |
| 2013/14 underlying operating margin | 7.2% | 4.9% |
| Net gearing | 70% | 59% |
| Price-to-book value | 2.5 | 0.86 |
Source: Company reports
What stands out to me is that the 16% decline in Marks and Spencer’s underlying operating margin is double the 8% decline seen in Morrisons’ underlying operating margin over the last five years.
Although Marks and Spencer still has the upper hand on profitability, this is driven by higher-margin sales of general merchandise, which are still falling, whereas food sales, which have lower margins, are rising.
In my view, M&S’s operating margin may fall further, before eventually stabilising.
I’m also not keen on M&S’s much higher debt levels, especially as the high-street firm doesn’t enjoy the freehold asset backing of Morrisons’ £8.6bn property portfolio: M&S currently trades at 2.5 times book value, whereas Morrisons’ shares are currently valued at just 85% of their book value.
What’s next?
Marks and Spencer’s share price is down by 20% from its 52-week high of 520p, at 418p. This leaves M&S shares trading on a 2014/15 forecast P/E of 12.4.
Remarkably, this is almost exactly the same valuation as the market has placed on Morrisons’ shares, which at 173p, trade on a forecast P/E of 12.8.
The big difference is yield: Morrisons’ whopping 7.5% prospective yield is barely covered by earnings, whereas Marks’ 4.3% prospective yield should be covered around twice by earnings.
We’ll find out more this autumn, when both companies publish their interim results, but in the meantime, I believe there are far better opportunities in the UK retail sector.
