Rewards outweigh the risks
Jan 16 2008 by Andrew Miller for The Journal
AS we wrote a couple of weeks ago, it’s been a mixed Christmas for the high street. It’s also been a distinctly mixed Christmas for Sir Stuart Rose, chairman of Marks & Spencer.
On New Year’s Day, he was knighted for services to retail. Then, last week, Marks & Spencer released a bleak Christmas trading update. Its shares plummeted 19%, wiping more than £1.5bn of the company’s value.
The trading update must have made uncomfortable reading for Sir Stuart. Over the past quarter, M&S’s like-for-like sales were down 2.2% on the previous year, below expectations, and food sales were particularly poor, with like-for-like sales falling 1.5%.
M&S’s revamped stores showed slower growth than the previous quarter. And even though sales were below expectations, M&S reported that it had cut its prices by an average of 6% over the period, in an attempt to compete with the likes of Primark – while neglecting to make sure its stock met demand in some areas.
Sir Stuart blamed tougher trading conditions for the downturn, but M&S has undoubtedly made some operational mistakes recently. These have raised questions over M&S’s ability to survive what is set to be a tough market in 2008. Yet we still think the rewards offered by M&S shares at current levels far outweigh the risks.
Several factors have influenced our judgement. Firstly, M&S management now intends to rein back its store refurbishment programme. M&S has spent £1.5bn in the last three years refitting its tired stores. Slowing down the programme should help reduce disruption for shoppers during the first half of 2008.
Second, M&S committed last year to buy back £1bn of its shares. This is set to continue, but since the share price has dropped sharply, at a much lower price than previously forecast – which should help earnings further. M&S needs to buy back 220 million shares before June, or 1.5 million per day, which should help support the share price.
Thirdly, M&S management is now satisfied that customers regard the stores as good value, so further price cuts are unlikely.And last and not least, M&S shares should also find support from the fact the group’s property portfolio now accounts for around half of the enterprise value.
We have revised our forecasts for 2008, and by our estimates M&S shares are now trading at a price/earnings ratio of around nine times. The 6% forecast dividend yield is covered nearly twice by earnings, and this yield is set to continue to grow.
All this means that we think the fair value for M&S shares is around 515p – more than 25% above the price at the time of going to press. If we’re right, the shares could be top Marks for your portfolio this year.
:: Andrew Miller is regional head of Barclays Wealth.
