Lloyds Banking Group (LSE: LLOY) and Marks & Spencer Group (LSE: MKS) are two of the least popular high street names on the stock market. Shares in both firms trade well below recent highs and appear to offer value, with well-covered dividend yields of about 6%.
I’m always on the hunt for an income bargain, so I’ve been taking a fresh look at each firm. Are these FTSE 100 stocks too cheap to ignore, or should we steer clear of this cut-price merchandise?
Out of fashion
Marks & Spencers’ long-running problems have been defined by the company’s struggle to get to grips with its clothing business. Another chapter was added to this saga on Thursday afternoon when M&S announced the departure of Clothing and Home boss Jill McDonald.
Press reports today have suggested McDonald was asked to leave. Perhaps this isn’t surprising after the company admitted during the final quarter of last year, it “sold out of a number of fast selling lines.”
Running out of popular items is a big mistake for retailers. It’s one that M&S can’t afford to make. This maybe why McDonald’s responsibilities will be taken over by CEO Steve Rowe, an M&S lifer with deep expertise in this sector.
The right time to buy?
Marks & Spencer does face real problems. The group’s £750m food joint venture with Ocado isn’t without risk, either.
But as I’ve said before, I believe there’s still some value in this business. The group reported sales of £10.3bn last year and generated underlying free cash flow of £589m, according to my calculations. That gives the shares a free cash flow yield of about 15%. Pretty good, if it’s sustainable.
That’s the crucial point. Can Rowe rebuild the group’s profit margins and return M&S to growth? Or will profits continue to decline as the firm struggles with an outdated store estate and an ageing brand?
The shares currently trade on about 10 times forecast earnings with a dividend yield of 5.6%, after this year’s cut. If Rowe can deliver the kind of improvements he’s aiming for, then I think MKS shares could be worth a look at this level.
Keep it simple
Lloyds Bank doesn’t seem to be able to get much love from investors. Shares in the group have drifted down from about 85p five years ago to just 58p at the time of writing.
As the stock has been falling, Lloyds’ profits have been rising. So has the bank’s dividend. So what’s the problem? One risk is that the bank’s profits depend heavily on the UK consumer economy, thanks to its £264bn mortgage book and £18bn credit card business. Alongside this, it has over £15bn in motor finance and has lent £32bn to small- and medium-sized businesses.
If the UK economy heads into recession, some of these loans may fall into arrears, causing profits to fall. On the other hand, the economy may not be about to crash. And even if it does, Lloyds’ balance sheet is much stronger than it used to be, thanks to post-2009 regulatory changes.
Taking all this into account, I think Lloyds 6% dividend yield looks a decent buy-and-hold choice for income investors.
