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?
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.