M&S Bucks The Trend

Marks & Spencer (LSE: MKS) announced positive trading figures against a background of gloom in the retail sector. So what is it doing right, and is it reflected in the share price?

M&S's fortunes have been quite a roller-coaster over the years. Philip Green's aborted bid for the company in 2004 at 400p per share -- a considerable premium on the 280p level at which it was trading pre-bid -- was a significant turning point. At that time Stuart Rose was drafted in as CEO, and the subsequent two years has seen a shift in emphasis at the group:

• clothing ranges have been re-vamped;
• suppliers have been placed under increasing pressure, and stock levels have been tightly controlled;
• stores are being refurbished;
• the successful M&S "Simply Food" concept is being rolled out; and
• the sell-off of non-core businesses will be completed this month with the disposal of Kings Super Markets in US.

But it has taken some time for the market to realise that times are changing at M&S. As recently as last May, shares were trading as low as 318p; they didn't break Philip Green's 400p level until October 2005, following a positive trading statement. Since then they have rallied to 585p -- up more than 80% in less than a year.

So what's the latest news from the company? According to this morning's announcement, UK sales in the January to March quarter are up 9.1% compared to the same period last year. Importantly, like-for-like sales (which exclude new store areas) are up 6.8%. Remember also that the comparable period last year included Easter; this would have added another 0.8% to the figures.

Contrast this to the overall retail sector: The British Retail Consortium, the trade association and lobbying group for the industry, this morning issued their "Retail Sales Monitor" figures for March. They make grim reading. Like-for-like sales for the three month period were up only 0.3%, and actually fell 1.4% for the month of March. M&S is clearly bucking the trend, and shares were up 4% in early trading.

The company estimates pre-tax profit of £745m to £755m for the year just completed, versus analysts' average estimates of £739m, so adjusted EPS estimates of around 31p/share look likely to be exceeded. That would put M&S on a PE of almost 19, roughly in line with the retail sector, despite its superior performance. But before investing in this company there are some risks to consider:

• if consumers are spending less, and are feeling less affluent, there is a risk that sales of M&S food would be hit. Rival Tesco (LSE: TSCO) is well covered in this regard, spanning the full range of foods from value to premium, but M&S is not;
• fashion is fickle. M&S got it wrong before, admittedly under different management, but it could happen again; and
• higher energy costs are a factor for M&S and its suppliers.

Also note that in recent months there has seen speculation that supermarket property portfolios would be moved into Real Estate Investment Trusts (REITs), thus benefiting from more favourable taxation. It may be completely coincidental that David Michels, a director of British Land (LSE: BLND), joined the M&S board as a non-executive director last month. However, March's budget clarified the restrictions on REITs regarding ownership and control, making them much less attractive to companies like M&S. If you are basing your investment on the possible gains from a REIT, you may want to think again.

On balance, I have confidence in Rose's ability to execute the recovery plan, and even after recent rises in the share price I do not regard M&S as overvalued.