The price of FTSE 250 stock Marks and Spencer (LSE: MKS) has been trending higher over the last couple of months. But, given it is well below its all-time high, I do think there might be reasons to believe the stock is undervalued.
An obvious place to start is with the company’s price-to-earnings (P/E) ratio and that of its peers.
Price-to-earnings ratios
Food and drug retailers listed on the London Stock Exchange have an average P/E ratio of 12.3 and for a diversified retailer, it’s 11.1. A weighted average of these two would be a good point for comparison. Since Marks and Spencer’s gets about 34% of its revenues from clothes and homeware, and 66% from its food business, those are the weighing factors.
The weighted average comes out at 11.5. Marks and Spencer’s P/E ratio is quoted at 10.4, so it looks undervalued.
Food glorious food
The company’s average operating margin of 3.9% in its food division is better than competitors like Aldi and Co-Op, which score 2.1% and 2.8% respectively. Those mouth-watering adverts seem to have done their job. Customers seem to be willing to pay a little more for treats at M&S Food. The tie-up with Ocado should help get the company’s food into more online baskets.
Suited and booted
A third of Marks and Spencer’s business is clothing and homeware. This has an average operating margin of 9% compared to 5.7% for House of Fraser. But it’s well behind the likes of Next, which gets 18.2%. Next does twice as much business online as it does in-store, which might explain the difference.
The good news is that Marks bought the technology of the now-defunct Thread.com. It gave personal stylist recommendations to online clothes shoppers based on their inputs and purchases. If integrated correctly, this could help drive online sales higher.
A well-known FTSE 250 stock
According to YouGov, Marks and Spencer is the most popular and fifth most famous home and department store in the UK. It scores well for popularity across generations compared to its peers, which is encouraging. I think this is a good sign for the company as it is easier to build awareness than it is popularity.
It is also a well-known food brand. However, it didn’t score as well when it came to the popularity of its food. It was more popular than some of the large supermarkets. But, It fell behind the discount supermarkets like Aldi and Lidl, which scored well. I think the survey might have focused on value for money. The M&S Food brand is built on being a cut above the usual in terms of quality but not necessarily cheaper.
Restructuring
Group operating margins declined from 13% in 2008 all the way to 2% in 2018. After years of restructuring, they are up to 5%. But they are still lower than individual businesses’ margins would suggest. That’s because adjusting and exceptional items are still being expensed at the group level, lowering the margins. It does not appear that restructuring is over yet.
It might well be that Marks and Spencer’s shares look undervalued because of uncertainty about the length and ultimate success of what is a bold and extensive restructuring plan. But, I am encouraged about the uptick in margins.
