Shares in Marks & Spencer (LSE: MKS) are down heavily today. That’s after the high street retail giant announced a £600m rights issue and 40% cut to its final dividend to fund a much-rumoured, now-confirmed joint venture with fellow FTSE 100 constituent Ocado (LSE: OCDO).
Are the company’s plans to finally enter the home delivery market and “transform online grocery shopping for UK consumers” sufficiently robust for new investors to get involved? Or could there further share price falls to come? Let’s start by looking at today’s deal in more detail.
Under the terms of the agreement, M&S has agreed to pay £750m to acquire a 50% share in the Ocado’s UK retail business. Eighty percent of this will come from selling new shares to investors.
The rationale behind the deal is that it will allow Marks to benefit from Ocado’s technology and deliver some much-needed growth. The latter will get access to the former’s products, brand and information on its 12m food shoppers from September 2020 “at the latest,” once its current deal with Waitrose expires. The joint venture will trade as Ocado.com.
In addition to generating cost savings of at least £70m per annum by the third year of the deal, M&S CEO Steve Rowe claimed that those currently shopping with Waitrose through Ocado would benefit from his firm’s lower prices. Quite whether consumers will want to make the switch remains to be seen, of course.
Show me the money!
Transformative or not, all this needs to be paid for. Clearly, news that the company has taken a knife to its dividend is bound to leave some investors smarting. Personally, I wouldn’t feel that aggrieved just yet.
Following today’s cut, the company intends to pay a final dividend of 7.1p per share. Since M&S has hinted that this marks the beginning of a “resetting” of the dividend, it’s worth applying the same cut to next year’s interim dividend. A 40% reduction from the 6.8p paid in January and added to 7.1p would leave M&S yielding 4.1% in 2019/20. That’s hardly awful.
More questionable is whether M&S is paying too high a price to acquire a 50% stake in a company that only made £80m in profit last year. Rowe doesn’t think so, having stated that the deal allows the retailer to move its food offering online “in an immediately profitable, scalable and sustainable way.” Time is money, and M&S’s leader is clearly in a hurry.
Not that Ocado’s owner will care. Its shares are up almost 5% today, giving some indication of who the market believes is benefitting the most from the deal.
How patient are you?
Clearly, M&S had to do something to revive its fortunes following years of falling sales. If market participants wanted decisive action, they’ve got little to complain about now.
But should those following an income and/or value-focused strategy be tempted to catch this falling knife? Only if they already hold a diversified portfolio of stocks, in my opinion.
At 12 times predicted earnings before markets opened this morning, the shares were already fairly reasonably priced but — with so much still to be confirmed — I wouldn’t expect a sustained recovery to the price anytime soon.
Short-term pain for long-term gain? Whatever happens, today’s deal marked a new, potentially fascinating chapter in the Marks & Spencer story.
Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.