Marks & Spencer has faced many challenges over the decades with unsuccessful turnaround initiatives. Just six years ago, its chairman Archie Norman cautioned shareholders that the well-known retail chain was on a “burning platform” and that substantial changes were necessary for survival.
Despite previous setbacks, the 140-year-old retailer has finally made significant strides: it has revitalized its brand, enhanced sales growth, reclaimed market share from competitors, and is ahead of its five-year transformation strategy.
The company, which re-entered the FTSE 100 index last year, is concentrating on upgrading the quality and pricing of its food and clothing ranges, investing in technology, and revitalizing its store locations.
The turnaround is largely attributed to its CEO, Stuart Machin, who is focused on gaining an additional 1% market share in both the food and clothing/homeware sectors by March 2028, alongside achieving operating margins of at least 4% and 10% in each division, respectively.
In the first year of its five-year plan, M&S met its margin objectives. The group reported a notable 41% rise in pre-tax profit to £672.5 million for the financial year ending in March; this surpassed analyst predictions, which ranged from £665 million to £705 million. The food division reported an adjusted operating profit margin of 4.8%, while the clothing and homeware sector, overseen by former Tesco clothing head Richard Price, achieved a margin of 10.3%.
Machin noted that part of this achievement can be attributed to shoppers shifting away from larger competitors like Waitrose. The market share saw an increase to 10% in clothing and 3.7% in food last year, a rise from 9.6% and 3.55% the prior year.
While progress has been encouraging, the international sector, often overlooked by investors, has not performed as well. This segment operates on a lighter franchise model and contributes just over 8% of the group’s operating profit. Sales in this division fell by 1% last year to £719 million, although shareholders seem reassured by recent leadership changes.
A larger concern for M&S is its partnership with Ocado, the online grocery service. The Ocado Retail venture, a 50:50 joint partnership, has failed to meet critical performance objectives, with profitability falling short of expectations. Currently, a dispute exists regarding a multi-million-pound payment based on unfulfilled targets. The venture had a valuation of £677 million at the end of March.
M&S is set to release its first-half results next month, with expectations for continued market share growth and pre-tax profits projected around £367 million. Shares have surged by approximately one-third this year, resulting in a forward price-to-earnings ratio of 13.9 times.
While this pricing isn’t particularly low, it appears reasonable compared to competitor averages, with Sainsbury’s and Next trading at 13.1 and 15.7 times, respectively. The current valuation of M&S shares reflects a company that is considerably more robust than five years prior, buoyed by rising margins and increased market share.
M&S’s turnaround is also bolstered by a healthier financial profile: net debt, excluding lease liabilities, has nearly halved over the past five years to £2.2 billion as of the end of March. The shares currently yield a modest 0.8%, although the company reinstated its dividend last year at 3p per share. A stronger balance sheet may eventually lead to more substantial cash distributions for patient investors.
Advice: Buy
Why: A more focused strategy is likely to yield further earnings growth.
Card Factory
Card Factory surprised investors with a 34% drop in adjusted pre-tax profit to £7.6 million for the first half of the year. The company attributed this decline to rising national living wages, freight inflation, and some strategic investments. The stock price plummeted over 15%, but with shares now trading at only 6.7 times anticipated earnings, one might consider whether Card Factory is worth adding to their portfolio.
This retailer specializes in cards, gifts, and celebration products, with over a thousand locations across the UK and Ireland, in addition to an online presence.
Card Factory has historically maintained strong margins by mass-producing products at significantly lower costs than its competitors. However, its gross margin fell by 4.2 percentage points to 32.6% by the end of July, primarily due to higher wages for store and warehouse staff, which accounted for 28% of revenue during the period, compared to 24% the previous year.
The discourse surrounding increased labor expenses and their effect on profit margins has been extensive; nevertheless, the company remains a strong cash generator. It announced an interim dividend of 1.2p last month, the first in five years, and reiterated plans to sustain a dividend cover of approximately three times throughout the fiscal year.
Card Factory has also laid out initiatives to manage rising costs and has maintained its guidance for the remainder of the financial year. Its medium-term goals remain ambitious, targeting £650 million in revenue, a 14% pre-tax profit margin, and the addition of 90 new locations by 2027.
If Card Factory achieves these benchmarks, investors might anticipate an implied compound annual growth rate of 8.8% from 2023 to 2027, as per analysis from Panmure Liberum, along with a return to pre-pandemic profit margins and cash flow.
Shares are trading at a forward price-to-earnings multiple of 6.7, compared to 16.9 for its digital competitor Moonpig. Card Factory seems well-equipped to address escalating costs, but investors might want to wait until margins stabilize before making any decisions.
Advice: Hold
Why: The business is adapting to higher costs.