There’s one stock I’m more positive on than most for 2017 and that’s Marks & Spencer (LSE: MKS). It has been a rough year for Marks. The company has continued to struggle to retain customers, and despite the publication of its massive business overhaul plan, the market still doesn’t seem to believe that the company will ever return to its former glory.
However, I believe that sentiment towards M&S is so negative that any positive news from the company will spark a massive rally in the shares.
Down but not out
Shares in the firm have fallen 22% year-to-date excluding dividends. At one point in the year, the shares dipped below the key 300p level, a threshold not breached since 2009.
These declines have pushed M&S’s valuation down to just 12.1 times forward earnings, which is one of the lowest valuations ever awarded to the group. Granted, it does deserve to trade at a low earnings multiple considering current City forecasts for growth. City analysts expect the group’s earnings per share to decline 17% for the year ending 31 March 2017, although with the crucial Christmas trading period still to come, these forecasts are likely to change over the next few months. Whether for better or for worse remains open to question.
So, what could be the catalyst that sends the shares higher by as much as 50% over the next 12 months?
Well for a start, if the company can meet or beat the City’s low expectations, investors could start to change their opinion of it. Secondly, management needs to reassure investors that the dividend payout is sustainable. If Steve Rowe and his team can meet this key goal, income investors will return to the shares, pushing the price higher and the yield lower. The five-year average yield for M&S shares is 4.1% and at this yield, the share price would be 460p, 30% above current levels.
The third factor that could see the shares re-rate is cash flow. In business, cash is king and those companies that can generate hefty amounts of cash year after year are usually the best investments.
The M&S business is a cash cow. Free cash flow per share is 34p on a trailing 12-month basis and using this metric, the shares are currently trading at a price-to-free cash flow level of 10.1, significantly below the industry average of 16.4. If the shares re-rate to a more suitable valuation, they could be worth as much as 550p, a full 57% above current levels.
Conclusion
So overall, shares in the retail giant appear to be undervalued after a punishing year for the company. However, there are now many catalysts that could push the shares higher including the return of income hunters, better than expected trading performance and bargain-hunter buying.
If any of these scenarios unfold next year, shares in M&S could easily return to previous highs. But that is, of course, a big ‘if’.
