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Where to invest on the high street, Primark or Marks ‘n’ Sparks?

Image: Primark. Fair use.

Results today from Marks & Spencer (LSE: MKS) show the enormity of the task facing new management as the company reported an 88% fall in half-year profits. Should investors back a turnaround at M&S? Or is Primark-owner Associated British Foods (LSE: ABF) a sounder bet? ABF also released results today and posted a 47% rise in profits.

Turnaround plans

M&S said revenue for the six months to 1 October increased 0.9%, but reported a fall in pre-tax profit to £25m compared with £216m for the same period a year ago.

The profit slump was largely due to one-off charges related to changes in pay and pensions, but underlying profit was also down, by 19%, as sales at the group’s troubled Clothing & Home division fell once again.

Management is planning sweeping changes to the UK estate, including the closure of 30 ‘full line’ stores and downsizing or replacing a further 45 to Simply Food stores. The International business is also to be overhauled radically with the company exiting lossmaking owned businesses across 10 markets and focusing on a franchise model.

Chief executive Steve Rowe hopes these changes, and a planned opening of over 200 new Simply Food stores by the end of 2018/19, will “provide a robust foundation for future growth and deliver value for our shareholders in the long term.”

Superficially attractive

M&S’s shares are trading at 349p, giving a superficially attractive trailing price-to-earnings (P/E) ratio of 10.8 and a dividend yield of 5.4% after the board declared an unchanged interim dividend.

However, other chief executives have come into M&S with promising plans over the last two decades but failed to deliver sustainable growth for the business. In addition to this uninspiring history, a couple of details in today’s numbers give me cause for caution. Food has now seen two consecutive quarters of like-for-like revenue declines, while M&S.com’s 0.3% rise is very poor compared with the double-digit growth being reported for the digital channels of many retailers.

Plenty of investors will doubtless be attracted by M&S’s relatively low P/E and high yield, but I believe there are better opportunities in the retail sector.

Tremendous growth opportunity

ABF today reported a year of progress across all its businesses. Pre-tax profit increased to £1,042m from £707m, although on an underlying basis the increase was 4.6% — in line with the group’s rise in revenue.

Revenue at Primark increased 9%, as 1.2m sq ft of new selling space took total space to 12.3m sq ft. In contrast to M&S, which only mentioned risks in relation to Brexit, ABF expects some adverse impacts, but also benefits and opportunities. For example, weakened sterling presents the group’s food businesses with “significant opportunities to replace imported food and build export markets..

ABF is well positioned to deliver strong top- and bottom-line growth for many years ahead, with Primark, which is now at an early stage of expansion in the US, being a particularly powerful engine.

I believe this FTSE 100 group represents a tremendous long-term growth opportunity for investors. I reckon that in 10 or 20 years’ time there’s a high probability ABF’s shares will have outperformed M&S’s, despite the Primark group’s much higher P/E of 25 and lower yield of 1.4%. For this reason, I rate the shares a buy at a current share price of 2,650p.

Are you worried about Brexit?

As I mentioned, ABF is set to see some negatives from Brexit but also some significant positives. Britain's momentous decision to leave the EU has undoubtedly shifted the outlook in different ways for different businesses.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.