Shares in FTSE 100 retailer Marks and Spencer (LSE: MKS) have dropped 15% from their 6 November high of £3.95. This is despite strong recent results, including its Christmas trading statement released on 9 January.
This disparity and its sub-£4 share price makes me think a serious bargain could be had here.
The Christmas update
This wasn’t just any Christmas update, this was Marks and Spencer’s Christmas update for the entire Q3 period up to 28 December.
It saw year-on-year like-for-like (LFL) sales rise 8.9% for its Food operation (to £2.581bn), ahead of analysts’ forecasts of 7.8%. And Clothing, Home & Beauty LFL sales increased 1.9% (to £1.305bn), again ahead of projections (for a 0.7% rise).
LFL sales measure the growth of a retail business from its existing stores and space, excluding the impact of new store openings or closures.
Despite this, the shares fell after the release. I think this was mainly due to the warning from CEO Stuart Machin that the external environment remains challenging.
Marks and Spencer was one of the 79 signatories of the British Retail Consortium’s post-Budget letter to chancellor Rachel Reeves. It warned of problems that may arise from the 1.2% increase in employers’ National Insurance.
It added: “The effect [of significant cost increases] will be to increase inflation, slow pay growth, cause shop closures, and reduce jobs, especially at the entry level”.
These are all key ongoing risks for Marks and Spencer, in my view.
How does the core business look now?
Before the 30 October Budget, the firm had published a series of strong results. For its fiscal year ended 30 March 2024, profit before tax (PBT) and adjusting items soared 58% year on year to £716.4m. Its half-year results issued on 6 November showed a 17.2% jump in PBT and adjusting items year on year — to £407.8m.
These numbers come two years into its ‘Reshape for Growth’ five-year strategy announced at its Capital Markets Day in 2022. This was aimed at refocusing on quality, innovation and value for money.
Even after the October Budget, analysts forecast Marks and Spencer’s earnings will grow 9.3% each year to end-2027.
And it is this that ultimately drives a company’s share price (and dividend) higher.
How undervalued are the shares?
Marks and Spencer currently trades at a price-to-earnings ratio of 13.4 against a competitor average of 27.8. So it is technically very undervalued on this basis.
This also applies to its 2.2 price-to-book ratio compared to a 5.2 average for its peers. And it is also the case with its 0.5 price-to-sales ratio against its competitors’ average of 1.4.
And a discounted cash flow analysis shows the shares are 43% undervalued at their present £3.35 price.
Therefore, the fair value of the stock is £5.88, although market unpredictability may move them lower or higher.
Will I buy the stock?
Aged over 50 now, I focus on shares that generate a yield of 7%+. Marks and Spencer only recently reintroduced a dividend, which is currently less than 1%. So it is not for me at my point in the investment cycle.
However, if I were even 10 years younger I would snap it up, based on its strong earnings growth potential.
