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How to trade the Marks and Spencer share price after FTSE relegation?

Iconic British retailer Marks and Spencer has been battered by a host of negative factors over the past few years: intense competition from food discounters and online fashion sites, the demise of the UK high street, store closures and costly mistakes such as overseas expansion. As a result, the firm’s share price has plunged by 33% over the last 12 months to 195p.

Now, for the first time, M&S [MKS] will be relegated from the leading index of UK shares – the FTSE 100. The change will take effect from 23 September.

 

Downward

The move has garnered a great deal of media coverage, as commentators debate whether this marks another gloomy stage in the terminal decline of the 135-year-old retailer. Its most recent annual pre-tax profit of £84.6m is lightyears away from the £1.1bn profit it recorded in 2007.

It may intensify talk of M&S potentially having to demerge or close either its clothing or food businesses. M&S are already shutting stores nationwide – 100 by 2022 – and retrenching from international expansion into cities such as Paris, as part of a restructuring programme. Other measures include fewer customer promotions. 

Operationally, industry experts expect its retail struggles to continue. Adrian Lowcock, head of personal investing at Willis Owen said: “It is a reflection of the times. High street retailers have been struggling for some time and M&S continues to look for that balance between quality and price.”

There is also some disquiet over its decision to pay £750million for a 50% stake in online grocer Ocado Retail. It gives M&S a presence in the sector and means it does not have to shell out millions on developing its own infrastructure but, as Hargreaves Lansdown points out, it is a lot of cash to pay for a business with £50million of EBITDA.

 

Market cap £3.84bn
PE ratio (TTM) 93.17
EPS (TTM) 2.10
Quarterly revenue growth (YoY) -2.90%

Marks and Spencer share price vitals, Yahoo finance, 5 September 2019

 

Chairman Archie Norman said it could take between 3 and 5 years for its moves to bear fruit and lead to sustainable, profitable growth.
That is a long time to wait for a share price recovery. Especially given possible headwinds from Brexit. "If there is a further fall in the pound because of Brexit that could hit retailers as they buy many imported goods in dollars. A wider downturn in the economy could also hit M&S,” said Hargreaves Lansdown.

 

Upward

Norman is urging investors to be patient. Referring to a potential relegation he said back in May: “When I went to ITV we dropped out of the FTSE 100 and the sky didn’t fall in. The business was the same business the day after.”

ITV [ITV] is now back in the FTSE 100, as are others who were demoted, such as supermarket Morrisons [MRW]. There is a return ticket for stocks if they can address their issues as M&S is doing. There is also the argument that, like a top football club that has been relegated, it will give them space to make those changes out of the spotlight.

M&S still has strong fundamentals. Its brand name and affection among UK consumers and ex-pats is strong. The firm cut its dividend by 25% to 13.9p in its last results but its annual dividend yield is a respectable 7.28%. 

“When I went to ITV we dropped out of the FTSE 100 and the sky didn’t fall in. The business was the same business the day after.” - Chairman Archie Norman

It’s restructuring plan has cost around £1.4bn to date, but rethinking its store presence, focusing less on discounts and moving into food delivery are meaningful steps.

In the short-term the share price may suffer from some volatility as FTSE 100 tracker funds sell off their M&S holdings. “It is a common strategy for hedge funds to buy a stock before it enters an index and short a stock before it comes out of an index,” Peter Sleep of Seven Investment Management told the Telegraph. “However, I would tell investors to be very careful of index arbitrage, you are swimming with the sharks.”

Instead of diving in you could just relax in your M&S jumper and wait for a potential upside in the FTSE 250.

According to a study from Smith’s Corporate Advisory companies that fell out of the FTSE 100 dropped by almost 19% in the two months beforehand but rose 2% in the period before the change actually happened. They then moved sideways in the following two months.

For M&S it is about the long game going forward. If that did include a demerger of food and clothing, then this could add to shareholder value.

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