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Why I believe Marks & Spencer shares could halve

Marks & Spencer (LSE: MKS) shares have been in a slump for several years now, but the recent results could see that decline continue. I feel that investors should avoid Marks & Spencer stock because the market is not factoring in the possibility of a collapse.

Profits almost wiped out

The half-year results showed some ominous signs that the nation’s well-loved retailer could be in trouble.

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Profit for the period fell to £136m from £162m (before adjusting items), but what will scare shareholders the most is that free cash flow dropped 69%.

The company is in serious danger of no longer being able to sustain itself. If the company can’t sharply reverse this trend, it will begin to consume cash rather than produce it – and the company’s dividend will be sharply cut even further.

That will definitely not please income investors, who won’t like that and may sell. Once the cash runs out at Marks & Spencer, the company will need to raise fresh equity and dilute or conduct a rights issue in order to prop up the deteriorating balance sheet.

Marks & Spencer is outdated

The problem is the business is a relic of a forgotten age. Founded by a Polish refugee, Michael Marks, and a cashier from Skipton in North Yorkshire, the initial partnership succeeded with their Penny Bazaar. This was revolutionary in a time of barter and haggling, because the ease of having everything a penny meant operations ran smoother.

But fast forward to now, and the business is sluggish, outdated, and is carrying a lot of fat. Management want to turn the business around to growth, but I fear they are going to run out of time.

Marks & Spencer has tried to revitalise its business through its food offering, which is showing growth. But it just isn’t enough to offset the declining sales in its clothing business. Like-for-like sales were down 5.5% in the first half of the year, which is going to put a strain on the business as it recently announced the turnaround was taking longer than expected.

The debt to equity ratio is growing

The company is carrying £4bn of debt, which is not huge compared to the current market cap of £3.7bn, but a lot of that debt is secured against high street property. And we all know how well the high street is doing…

The problem is that the debt is not falling anywhere near as much as the equity value, meaning that the company is becoming increasingly geared. Recent stocks such as Thomas Cook, Carillion and Debenhams were all saddled and consequently crippled by debt.

With the share price currently trading at multi-year lows, I think the shares can fall a lot further.

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Michael Taylor has a short position in Marks & Spencer shares. 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.