Marks and Spencer’s (LSE: MKS) turnaround is starting to take shape and this news has sent the company’s shares to a six-year high. However, it’s unlikely that this rally will last and investors could use this chance to sell up and buy Next (LSE: NXT) instead.
Turnaround in progress
There’s no denying that Marks’ turnaround has started to take shape. Clothing sales and homeware sales at established stores rose by 0.7% in the 13 weeks to 28 March, bringing a halt to four years of declines. But in many respects, this is too little too late.
Marks has been trying, and failing, to re-ignite sales growth of clothing and homeware items for several years to no avail, while smaller, more nimble peers (like Next) have eaten away at the group’s market share.
What’s more, Marks is an old fashioned, bricks-and-mortar retailer with a high-cost base, which constricts profitability. Next, on the other hand, has a low-cost base, wide profit margins, and a high cash conversion ratio.
High returns
The difference in return on capital employed between the two companies really illustrates this point. Simply put, ROCE is a telling and straightforward gauge for comparing the relative profitability levels of companies. The ratio measures how much money is coming out of a business, relative to how much is going in and is a great way to measure business success.
According to my figures, for 2014 Marks reported a respectable ROCE of 15% but Next’s ROCE came in at a staggering 69%.
Standing out
It’s these kind of returns that make Next stand out from its peer group. Additionally, the company is devoted to returning excess cash to investors.
Last year it paid out £223m in special dividends on top of the regular payout giving a total dividend yield of 4.6%. Figures suggest that the company’s total dividend issuance this year will give investors a yield of around 5%. City figures suggest that Marks’ shares will only yield around 3% this year.
Further, Next is one of the few companies that has a disciplined stock repurchase programme in place. Specifically, the company will only buy back shares if it can earn an 8% return on the repurchase.
This disciplined strategy has helped the company increase earnings per share by 1000% over the past 15 years. Operating profits have only expanded 350% over the same period.
Still, this kind of growth comes at a cost and Next’s shares aren’t cheap. The company is currently trading at a forward P/E of 17.3, but Marks’ shares are also trading at a lofty forward P/E of 17.5, despite the company’s sluggish growth. Next is expecting to report sales growth of 1.5% to 5.5% this year.
Foolish summary
So overall, when Marks and Next are placed side by side, Next comes out on top. That’s why I would sell Marks and use the cash to buy Next.
