Marks & Spencer shares look cheap – should you buy in?

The Marks and Spencer (LSE: MKS) share price has been a perennial disappointment for investors over the past 20 years.

Since May 2002, the share price has lost 63%. On a total return basis (ie including dividends) the picture is a bit better, but investors have still lost money.

The company’s story is one of strategic missteps, poor capital allocation decisions and management taking the firm’s brand for granted. As the retail landscape has shifted, M&S has failed to move with the times, and the business has been run with the single goal of generating as much cash as possible to fund shareholder returns. Improving the customer experience has often been neglected.

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If you’ve ever visited one of the company’s larger stores (at least prior to the launch of its new strategy), you’ll know what I’m talking about. Stores were often tired, jumbled and faded, with a lack of stock and some odd fashion choices.

However, in 2020 the company launched its “Never the Same Again” programme with the goal of refreshing M&S and positioning it for the 21st-century retail landscape.

Is the Marks & Spencer comeback crumbling?

The market’s initial reaction to the strategy was incredibly positive. Despite the pandemic, between July 2020 and the start of this year, Marks & Spencer shares returned more than 160% excluding dividends, compared to a return of just 25% for the FTSE All-Share Index.

Unfortunately, this year the stock has lost some of its shine. M&S shares have crumbled by around 45% due to wider concerns about the cost of living, and the impact on consumer spending. Rising costs also threaten profit margins and could throw a spanner in the turnaround plan, which has really only just begun.

However, figures for the year to the start of April show that the group is moving in the right direction at least. Pre-tax profit, excluding exceptional items, totalled £523m, up £50m on the previous financial year. Meanwhile, revenues grew by 7%. Excluding lease liabilities, net debt also fell from £1.1bn to £420m.

These numbers are pretty impressive, especially compared to the rest of the retail sector. Rampant competition is proving a significant headwind for e-commerce retailers such as Boohoo (LSE: BOO) and ASOS (LSE: ASC), while bricks-and-mortar retailers are struggling to compete with the online players, which have a lower cost base.

M&S is both a food retailer and a clothing and homewares shop, which gives the business a competitive edge in a highly competitive market. There are three branches within walking distance of me right now, all M&S Food Halls, and they’re always quite busy. Located next to (or above) London Underground stations, they offer click and collect services for other M&S products and are a one-stop shop for travellers who want to pick up food or other products on the way to or from work.

Admittedly, this is a very London-centric view of the enterprise, but I think it illustrates how M&S is adapting and changing to the “new normal” in the retail market. In my experience, no other retailer offers the same kind of experience. I can order something from the company online before 11AM today, and pick it up on my way into the office tomorrow, along with lunch and other essentials if I want them.

By revamping its food business, and focusing on the consumer rather than the shareholder, M&S has been able to upgrade its profit forecasts twice during the last financial year. That’s why Marks & Spencer shares became a market darling in 2021.

The M&S share price is not immune from the cost of living crisis

Despite its progress over the past couple of years, M&S is now warning that consumer confidence will hurt growth in its current fiscal period. Ocado Retail, the online grocer that M&S jointly owns with Ocado (LSE: OCDO), which has been a key area of growth for the group since the partnership began in August 2019, is now only expected to report sales growth in the “mid-single digits,” compared to initial indications of 10% year-on-year growth.

Management also expects the profit contribution from the joint venture to be “minimal” this fiscal year. Last year the group earned £13.9m from Ocado Retail and during the pandemic, M&S’ share of the profits totalled £78.4m.

Ocado, which also released its figures for the quarter to the end of April today, noted that while customer numbers have risen 12% year-on-year, sales have declined as “consumers respond to short-term discounts and promotions,” due to the cost-of-living crisis which has compounded “the impact of a return to more normal consumer behaviours as restrictions have ended.”

These headwinds, as well as M&S’ decision to exit the Russian market (costing £102m in sales annually) means it has started the financial year at a “lower adjusted profit base”.

This warning on growth, as well as the decision not to pay a dividend for the second financial year in a row, is disappointing for investors.

Nevertheless, while some might see this as a reason to avoid M&S, I think holding back on a dividend is a good decision. In the five years to the end of 2019, the firm paid investors around £300m a year in dividends. Considering the current economic environment, the decision to use excess cash to cut debt and invest in growth instead is the right one.

Yes, the organisation is facing an uncertain environment and yes, it has made plenty of mistakes in the past – but M&S seems to be heading in the right direction.

What’s more, after recent declines the stock appears relatively good value. According to Refinitiv broker estimates, the shares are selling at a 2023 price/earnings multiple of 7.4. There may be more pain ahead for the retailer and the UK economy, but it seems to me there’s already a lot of bad news reflected in this valuation.