Buyers Beware: Marks and Spencer Group Plc Is Neither J Sainsbury plc Nor NEXT plc

Marks and Spencer Group (LSE: MKS) shares have risen by more than 16% so far this week, after the firm’s interim results beat expectations.

Yet this week’s results weren’t really that amazing — a 2.3% rise in pre-tax profits, and a 3% increase to the interim dividend — so what’s behind these gains?

New dawn?

Sadly, I’m not sure that this week’s results represent the new dawn investors are hoping for.

Firstly, the firm has failed to solve the problem of falling clothing sales: like-for-like clothing sales were down 2.2% during the first half. Online sales also fell, thanks to the disastrous launch of the new M& website.

Secondly, although food sales continue to rise, profit margins on food are lower than on clothing sales. This is pushing down M&S’s operating margin, which has fallen from 9.9% in 2010, to just 7.6% in 2014.

In my view, Marks and Spencer is standing still — at best — and looks increasingly expensive, on a 2015 forecast P/E of 14, and a prospective yield of 3.9%.

What are you paying for?

Can M&S justify a premium price tag for its shares? Operating profits at M&S have fallen from £852m in 2010 to just £694.2m in 2014, and until this week, the firm’s dividend had not risen since 2011.

In contrast, Next‘s (LSE: NXT) operating profit has risen from £529.8m in 2010, to £822.8m in 2014, powered by a reliable 20% operating margin. Next’s dividend has also outperformed, rising by an average of 14% per year between 2010 and 2014.

What about food?

Marks & Spencer’s focus on high-end convenience foods means that it enjoys higher profit margins on food sales than the main supermarkets, but this is already reflected in the firm’s share price.

On the other hand, J Sainsbury (LSE: SBRY) (NASDAQOTH: JSAIY.US) also sells relatively upmarket food, but is out of favour at the moment. Despite also making gains this week, Sainsbury shares boast a 2015 forecast P/E of just 9.8, and offer a 5.2% prospective yield.

Sainsbury’s current 263p share price is also nearly 20% below its tangible book value of 313p, giving an added margin of safety for investors.

M&S in retreat?

I cannot see any reason to justify further gains in Marks and Spencer’s share price, and suspect that a retreat is likely over the next few months. In my view, the shares are a hold at best.

Don't agree?

You may not agree with my view of M&S, but you probably will agree that if M&S was ever forced to cut its dividend, its share price would fall sharply.

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Roland Head does not own shares in any of the companies mentioned.