Marks and Spencer (MKS) shareholders have certainly had a rocky ride this past decade. The share price has zigged and zagged violently from between 750p and 200p and currently sits near the middle of that range at 501p.
My question, as always, is this: Is the company defensive enough for me to trust my money with, and are the shares good enough value at the current price for me to expect a reasonable return from dividends and capital gains?
Slow, slightly choppy growth
As a defensive value investor, I’m only interested in companies that have a decent chance of growing at or above the rate of inflation whilst paying me a steadily increasing progressive dividend.
The companies that are most likely to do that in the future are those that have already managed it in the past, so let’s have a look at Marks and Spencer’s financial results over the last few years.
The picture here is of limited growth, with some earnings volatility and a disappointing but perhaps somewhat understandable dividend cut during the economic crisis.
Marks and Spencer’s overall growth rate has not been outstanding at just 2.8% per year. That is marginally above average over the period, and more or less matches the rate of inflation.
In terms of growth quality, the company managed to make a profit and pay a dividend every year, which is a start.
However, the earnings and dividend volatility put a question mark over the reliability of that growth. In total, the company managed to make and grow sales, profits and dividends 83% of the time, which is also marginally above average.
From a purely accounts-based point of view, Marks and Spencer has produced slightly more defensive results than the average company, which at least means that it is worthy of further consideration.
Medium levels of debt and quite a big pension fund
Profits and dividends are nice, but they’re not worth much if the banks effectively own and control the business.
On the debt front, Marks and Spencer does quite well. Its total borrowings are listed as £2.3 billion. That’s 2.5 times £915 million, which is an estimate of the company’s average annual net earnings through the next business cycle (which I call the future earnings power, and my usual limit on debt is five times that amount).
On the pension liability front, the current liabilities are £6.7 billion. Although the plan is in surplus, it is still quite a big liability, which is 7.4 times my estimate of the company’s future earnings power (10 times is my usual maximum).
In terms of the risks associated with financial liabilities, it looks like MKS is okay, at least on these measures.
In summary, then, from a purely quantitative point of view, Marks and Spencer is a slow and not particularly steadily growing company that has medium to slightly high financial obligations.
Although not exactly inspiring, those results are good enough for me to want to carry on because, at the right price, it could still make a decent defensive value investment.
Building the investment story
A company is far more than just the numbers it produces, so it’s usually a good idea to have a look at what it actually does and whether or not there is a reasonable chance for prosperity in the future.
In Marks and Spencer’s case, most people already know that it has long been a leading high-street clothing and food retailer, with a history dating back more than a century (somewhat lovingly detailed on their Marks In Time website). As a long-time M&S shopper myself, I understand their principles of quality, value, service and trust, and I have relied on it having the same sort of good quality, mainstream clothing in stock over the past four decades.
Its size and the M&S brand are competitive advantages, but the brand has to be worked on constantly through marketing, and it has struggled to expand beyond the UK, which is pretty much saturated in terms of M&S stores.
While it seems unlikely that M&S will go bust or shrink dramatically any time soon, it also seems unlikely that it’s suddenly going to switch into high-growth mode.
So while Quality/Value/Service/Trust may be its principles, its future growth may not be much better than the 2.8% annual growth it’s produced in the last decade.
Some quality, but little in the way of value
Given that the company has been growing at less than 3% a year, any chance of a decent return will have to come from either a high dividend yield or additional capital gains from a share price re-rating.
Currently, the dividend yield for Marks and Spencer at 501p is 3.4%, while the yield on the FTSE 100 at 6,800 is also about 3.4%. So this is no high-yield investment.
If decent returns can’t be had from the dividend, and there is no obvious reason to expect market-beating dividend growth, what about capital gains from a re-rating?
The FTSE 100 is currently valued at 14.3 times its average earnings over the past decade (or PE10, the cyclically adjusted and more reliable alternative to the standard PE ratio). Marks and Spencer at 501p has a PE10 ratio of 14.8 times.
For Marks and Spencer to be re-rated upwards, the market would have to have a reason to give it a premium valuation. Premium valuations usually belong to companies that have proven histories of exceptional growth or are very likely to grow quickly in the future.
But M&S doesn’t have a history of rapid growth, and rapid future growth doesn’t appear to be the most likely outcome in the future either. Therefore there is no reason to expect an upwards re-rating of the share price.
It looks like Marks and Spencer is a market-leading company, growing at about the average rate with average consistency. Despite that ‘average’ description, it is a good enough company for me to want to buy it, but only at the right price.
At 501p, the shares have an average dividend yield and an average valuation based on PE10. At this price, my assumption is that future returns from Marks and Spencer shares will be about average; in other words, no different from an investment in a FTSE 100 tracker.
That’s okay, but I think there are many better alternatives out there.
Currently, the company ranks at number 84 out of 234 consistent dividend payers on my stock screen. To get me excited about buying into M&S, I’d have to see it become a top 50 stock, at which point it would have a much more attractive dividend yield and a better chance of an upward re-rating.
But that will only happen at a considerably lower share price than we have today, and so, for now, it remains on my watchlist.
Disclosure: I do not own any shares in Marks and Spencer.