As Christmas approaches, are these retailers contrarian opportunities or falling knives?

Christmas is on its way. Over the next few weeks, retailers will be doing everything they can to get us through their doors (real or virtual) and buying their wares. However, with Brexit at least somewhere on the horizon, inflation predicted to rise and concerns over what Trump’s presidency might mean for the global economic outlook, more UK consumers are being cautious with their spending and where they shop than ever before.

Given this, it may be pertinent to look at two once-hugely-popular retailers who have fallen on hard times – Marks and Spencer (LSE: MKS) and Sports Direct (LSE: SPD). Will the festive period kick-start a revival for both or does more pain lie ahead?

Good times gone?

2016 hasn’t been kind to M&S, but you could say that about many of the last 20 years too. Last week’s uninspiring interim results revealed a 18.6% slump in underlying pre-tax profit, thanks to another drop in Clothing & Home sales. This placed even more pressure on the shares which now languish at 340p, only a few pence more than their price five years ago. Although dividends may have helped cushion the blow, it’s hard to argue that the performance in recent years has been anything but disappointing for long-term investors. With online competitors drawing customers away, it’s unsurprising that CEO Steve Rowe is cutting the company’s reliance on clothing, shutting stores and focus more on developing its food offering, which continues to be warmly received.

But if M&S investors have had a bad year, it pales in comparison to that endured by Sports Direct’s owners. Concerns over working conditions and the treatment of staff heaped pressure on the company earlier in the year. The recent allegation that it recorded private discussions between MPs on a recent visit to its Shirebrook warehouse hardly helped matters. Forget growing earnings, I suspect most shareholders would be satisfied if Sports Direct simply managed to stay out of the spotlight for a while, especially as the share price has more than halved in a year.

Worth the bother?

While it’s probably an understatement to say both companies are rather unpopular with the market at present, this does leave their shares trading on fairly reasonable forecast price-to-earnings (P/E) ratios of just 11 for M&S and 16 for Sports Direct. Using an extremely rough rule of thumb that anything less than 10 is cheap, it’s not surprising if value-focused investors are starting to take notice of both companies, particularly the former.  

Distinguishing a contrarian opportunity from a ‘falling knife’ isn’t easy but I’m inclined to avoid both shares for now. While Sports Direct could do little wrong before this year’s antics (high returns on capital, consistently rising earnings and a strong balance sheet saw investors flock to the stock), the company still has a lot of work to do to restore its image, which won’t happen overnight. Moreover, I’m not convinced that sporting gear tops most Christmas wishlists.

Although M&S food outlets are hugely popular and likely to do well over the festive season, the company’s lacklustre performance over an extended period, coupled with intense competition from other retailers (both online and in-store) suggests investors should buy its turkeys but not its shares.

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Paul Summers has no position in any shares mentioned. The Motley Fool UK has recommended Sports Direct International. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.