Tuesday, 10 July 2012

What "Next" for Marks and Spencers?

Marks & Spencers Group @ 325.2p, +4.2p (+1.31%)
Next @ 3188.72p, +18.72p (+0.59%)

Intriguing to see the soap opera that is Marks & Spencers.
Same old, same old would seem to be the mission statement as the latest CEO, Mark Bolland, unveils another disappointing set of figures, a new store concept roll-out, and another restructure with the revolving door of retail stars joining and leaving (QUARTER 1 2012/13 INTERIM MANAGEMENT STATEMENT).

Poached from Morrison's, the supermarket chain, Bolland appears to be struggling to get to grips with the complex retail beast that is M&S and the ongoing image problem.
His background is Sales and Marketing but his experience has been quite niche, namely Heineken. And, sorry to say it can never be said that Heineken has a confusing image problem.

So difficult to justify his leaving Morrison's after embarking on an acquisition and catch up strategy there which has yet to bear fruit but his ambitions and the rewards offered by M&S were obviously too much to refuse.

As it stands today's 2nd quarter update saw:
- group sales down 0.7% comprising:
- UK sales down 0.9% comprising
- food sales up 2.9%
- non-food down 5.1%

On a like for like basis (ignoring new openings/closures):
- UK sales were down 2.8% comprising
- food sales up 0.6%
- non-food down 6.8%

A real horror show in the UK non-food segment then which, speculation suggests, has resulted in Kate Bostock, (once of Asda: George and Next), leaving the company by "mutual consent" (www.sharecast.com: GM director Bostock pays the price at Marks and Spencer).

Coming in will be Belinda Earl (once of Debenhams and most recently Jaeger), as Style Director, reporting to John Dixon, the soon to be appointed Executive Director of non-food.

Bizarrely, Dixon is currently the Executive in charge of food which looks to be the one success story here. So its a good job that food is exactly the same as non-food in order to guarantee success... not!

What a strange decision and no reflection on Dixon who despite a previous role in food buying served as Stuart Rose's executive assistant whilst also looking after Home and M&S Direct before being put in charge of food retail.
Food retail is itself a hugely competitive market but M&S has managed to grow sales in a difficult market under Dixon.

Most of the blame has been put on the weather but the deteriorating share price of M&S has now seen its market capitalisation fall below that of rival retailer Next.
Next is now valued at £5.265 bn v. M&S's £5.214 bn!

A bizarre situation given that:
- Next has sales in the region of £3.5bn v. M&S's near £10bn.
- Next has £56m in the bank v. M&S's £196m
- Next has 276% net gearing (debt v. net assets) v. M&S's 74%
- M&S's property portfolio is valued at circa £2.5bn, almost half of that market capitalisation.

- Next is generating a pre-tax profit margin of 16.8% whereas M&S is generating a lowly 6.6%.

In 2008 M&S generated £1.1bn of pre-tax profit on sales of £9bn (12.2% gross profit margin) whereas today sales have increased by circa. 10% to £9.9bn but pre-tax profits have fallen 42%.

In contrast Next sales in 2008 were £3.2bn and profits were £428m so have continued within a similar range over 5 years for revenues but pre-tax profits have increased slightly.
More significantly that high % debt figure was much higher still in 2008 when it stood at a whopping 456%.
But the share price is now 3185p. 

That seems a lot of recognition for what is still a high debt figure in the fickle fashion and home retail markets. The Next business model has also changed somewhat as the company looks for maintaining/increasing sales and profits.
It used to be that Next only sold Next branded items but today it sells all manner of fashion and electrical brands throught its "customer database" particularly its subscribers to the Next Directory.

So 2 key points here for me: Next is potentially overpriced and; M&S is potentially underpriced.

In the case of Next, at 3185p they stand on a a current pe ratio of 12.6 times falling to 11.9 times if profits come through as forecast. Pre 2008 this would not seem to be too much of a premium but in light of the economic climate and the fact that Next no longer has a particular differential to other retailers (selling non-Next brands) it is open to competition from newer cooler specialists.
Its success with the Next Directory demonstrates that catalogue shopping is still viable but, from my experience, there are now so many coming out that they are no longer that originally conceived coffee table item.
Many, many customers have cottoned onto the the "Next" sale so the probablitity of finding a bargain is diminishing and "waiting" for these events could yet impact new season sales despite the experience being more like a riot.
The goal of every new season retailer has to be to sell out of its stock at the beginning of the season rather than the end.

But then again, in the case of M&S, the assets and financials are solidly in place but the retailer is just not able to attract and hold onto enough customers so trying to buy for recovery could see one holding for a very long time. It has waves of interest: Per Una; Autograph etc but appears unable to capture and hold the next generation of customers due to an ongoing identity and image issue.
At 326p the shares stand at 9.34 times current earnings.
The twice covered 5.5% yield adds some attraction but I would still want some faith in management and strategy. The company seems to eat up Executives with only Stuart Rose seeming to have shown any longevity in recent times.

Another opportunistic approach might come from Philip Green perhaps but I wouldn't hold out for this or expect that it would be any more value enhancing to shareholders.

So interesting to see M&S on a forecast 5.5% yield and a valuation that puts it behind Next despite a property portfolio covering half of it.
Perhaps that would be how to look at them, as a solid high yielding asset with some as yet unrealised potential for capital gain. Sounds much like a utility though but without the utilitarian sector's defensive qualities.

As for Next, the share's seem far too expensive and not for me given the current climate. There may be far too much emphasis being placed on its Next Directory subscriber base as customers can be fickle and once turned, even the most loyal can take some convincing to return as M&S, Tesco and others can vouch for.

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