High street fixture Marks & Spencer (LSE: MKS) has struggled for two decades. It’s been a serial disappointer for long-term investors. Here, I’ll explain why I’d happily sell the stock today, and buy FTSE 100 software giant Micro Focus International (LSE: MCRO) instead.
History repeats
Numerous management teams have tried to crack the conundrum of how to get M&S on a path to sustainable growth. Multi-year transformation plans have come and gone. The dividend was slashed by 37.5% in 2000 to help fund one attempt, and by 33.3% in 2009 to help fund another.
When M&S embarked on its latest transformation plan, I wrote that I wouldn’t be at all surprised to see the past repeat itself and the dividend rebased. This has now happened, with the company having announced a 40% cut, alongside a rights issue to raise up to £600m.
Expensive joint venture
The reason for the cash call is to invest in a joint venture with online grocer Ocado. Management reckons this is “a strategically compelling route to unlock growth for M&S Food.”
I’m not convinced. To me, it smacks of M&S having to do something, and desperation in the price it’s paying (up to £750m, including a deferred consideration of up to £187.5m, payable after five years).
Furthermore, the dividend cut doesn’t appear to be necessary on the known information, which suggests to me the joint venture may need further investment, or the company needs to up capital expenditure in core M&S. Whatever the reason for the seemingly disingenuous dividend cut, I see a perennially struggling business with an expensive joint venture that may or may not work out.
At a current share price of 282p, M&S trades on 10.2 times trailing 12-month earnings (with a rights issue to come, which will be dilutive to future near-term earnings per share). Meanwhile, a 40% dividend cut implies a forward yield of 4%. Given its long history as a serial disappointer, I just don’t see this as a stock I need to own.
Challenging integration
Micro Focus International hasn’t been without its problems recently. These stemmed from its reverse takeover of the software assets of Hewlett Packard Enterprise in September 2017. Integration was more challenging than expected. However, management saw no underlying issues with the end market of the product portfolio.
Following an encouraging trading update in November last year, I was hopeful the company’s annual results in February would be a catalyst for improved investor sentiment. This proved to be the case, with management reporting a significantly lower decline in revenue than it had guided, and saying “we believe the most disruptive issues experienced since completion are now behind us.”
Good value
The share price has risen strongly since the results, and the company still has work to do, but I continue to see good value in the stock at a current 1,925p. This represents 11.5 times forecast earnings for its financial year ending in October, and 10.4 times forecast earnings for fiscal 2020.
Meanwhile, the current-year forecast dividend gives a yield of 4.3%. This rises to 4.75% for fiscal 2010, with a forecast 10% rise in the payout (in line with earnings). All in all, I’d happily sell M&S to buy this FTSE 100 growth stock, which also offers a superior dividend yield.
