Speculation is growing that Marks & Spencer (LSE: MKS) shares could become a takeover target.
Over the weekend, it was reported that US private equity giant Apollo Global is considering an offer for the group.
This is not the first time Apollo has been associated with a UK retailer. Earlier this year, reports suggested that the business was running the rule over Sainsbury’s ahead of a potential offer for the supermarket group.
A bid never emerged, but it highlighted the fact that overseas investors see a lot of value in the UK retailers.
A year ago, I would not have put Marks on a list of companies that might attract interest from private equity. But a lot has changed over the past couple of months.
Turning the business around
At the end of August, shares in the retailer jumped 11% after it issued a surprise profit upgrade. It now expects annual profits to beat previous guidance of £300m to £350m.
The food division has been the star performer. Revenues have outperformed expectations, rising 10.8% year-on-year for the 19 weeks to 14 August. Compared to pre-pandemic levels, sales were 9.6% higher.
Revenues at its clothing and home division were still 2.6% lower than pre-pandemic levels during the period, although digital sales soared 62% and now account for 35% of total sales.
According to reports, Apollo believes that the company’s food and online businesses are incredibly undervalued. The joint venture with Ocado is particularly interesting.
Marks invested £750m in the joint venture back in 2019 for a 50:50 stake.
There have been reports that the retailer is weighing up an acquisition of the 50% of the joint venture it does not already own. This would have been all but impossible a couple of years ago. However, the retailer’s recovery now means it has the cash flow and balance sheet flexibility to pursue such a deal.
Marks’ overall recovery and expanding online presence are attractive qualities. It is also interesting to note that the retailer’s food business is growing at a double-digit rate in the relatively competitive UK grocery market. This suggests that consumers love its offering and are willing to pay more for the premium product.
Marks & Spencer shares are on offer
Considering all of the above, it is not surprising to hear that Apollo may think Marks & Spencer shares are undervalued. At the time of writing, the stock is trading at a forward price-to-earnings (P/E) multiple of just 12.3. I think this underestimates its growth potential.
Of course, there is no guarantee any offer will be made for the business. Nor is there any guarantee that its turnaround will continue. As the UK economy starts to recover from a pandemic, consumers may return to normal shopping habits. Food inflation may also push consumers away from Marks’ premium products.
Still, even after taking these risks into account, I would be happy to buy the stock for my portfolio today as a recovery play. After lacking direction for a decade, it seems as if the group is finally back on track.
