The last time I covered FTSE 100 retail behemoth Marks and Spencer (LSE: MKS), I concluded, with profits falling, shares in the business looked “fully valued” at 11.8 times forward earnings, and as a result, I thought it might be best if investors stayed away, despite rumours of a possible tie-up with online retailer Ocado.
A few weeks after my article, Marks officially announced that it is going into business with Ocado, and investors will be paying for the privilege.
Specifically, at the end of February, the company announced it i spaying £750m to acquire a 50% share in the Ocado UK retail business funded with a £600m rights issue and 40% dividend cut.
No panacea
Management seems to believe that this deal is the solution to Marks’ problems, but I don’t agree. While introducing an online offering might help improve brand sales, it is notoriously difficult to make money in this business. Indeed, even Ocado, which has established itself as one of the world’s leading authorities on grocery delivery over the past decade, hasn’t been able to achieve profitability.
Getting customers to convert to Marks’ brand could be another challenge. The company has spent hundreds of millions of pounds investing in its food offer over the past few years, but despite this, sales are currently falling.
It posted a 2.1% fall in like-for-like food sales to £1.7bn for the third quarter ending 29 December. The option for online delivery might draw some consumers back to the brand, but will enough consumers return to justify the cost? I reckon it’s unlikely and that’s why I’m a seller of the stock today.
Pushing ahead
As Marks struggles, online-only fast fashion retailer Asos (LSE: ASC) is powering ahead. While I’ve been a seller of the company in the past on valuation grounds, considering the state of the retail industry, I think Asos’s outlook is currently better than most — its outlook certainly seems brighter than that of Marks.
Today the company reported a 13% increase in reported sales for the three months to the end of February lead by a 14% increase in UK sales to £244m, making it the group’s largest market. Unfortunately, this growth missed expectations, and the shares have been punished as a result. Nevertheless, I think the declines could present an opportunity for growth investors.
Rest of world sales leapt 20% in the same period, and the firm’s recently established US business is primed for explosive growth. Even though US sales only ticked 4% higher in the three months to the end of February, management noted that “demand far exceeded our expectations” at its newly opened Atlanta warehouse, which caused a “significant short-term despatch back log.” These issues are now resolved, and we should start to see improved growth out of the US as a result going forward.
After taking all of the above into account, it looks as if the company is well on the way to hitting the City’s sales growth target for the full year.
Analysts are forecasting growth of 15.4%, although they also think that, due to higher capital spending and margin pressure profits will slide 48%. Falling profitability isn’t ideal, but a rebound is expected in 2020 where analysts have pencilled in growth of 55%. However, I think better than expected performance and the company’s US division, could blow this target out the water.
