UK Edition
Questor: we dodged a value trap at Pearson but fell into one at M&S. Time to move on
Questor share tip: Marks & Spencer’s valuation looks tempting but the pace of change feels too slow as the retail revolution continues
It seems fair to say that City analysts’ reaction to their meeting with Marks & Spencer bosses last week was at best lukewarm, leaving us with a dilemma.
This column’s sense remains that the M&S chairman, Archie Norman, and chief executive, Steve Rowe, are more willing – and able – to make the difficult choices than previous management teams as they seek to effect a turnaround.
Yet the pace of change still feels slower than ideal and building a portfolio is about finding the best place for your money – one story may be good, but others may be better or safer.
In the current environment, where markets do not feel like they are on the firmest of foundations and any slip is severely punished, it may therefore be safest to give up reluctantly on this one, swallow the loss and deploy the capital elsewhere.
Granted, the valuation still looks tempting on less than nine times forecast earnings with a yield of about 7pc. Nor is there a particular balance sheet problem, as the pension fund is in surplus and profits covered interest costs last year by a factor of 5.7 times.
That said, the 2019 annual report showed £4.1bn in lease commitments on a store estate that the firm keeps writing down in value.
Also, M&S does not inspire the confidence that Next does when it comes to its multi-channel offering, while profit forecasts are still dribbling lower (from £512m pre-tax after May’s full-year results to £479m now) and both earnings and cash flow cover for the dividend are still below the threshold of 2 that provides some protection should anything else go wrong unexpectedly.
We think we are dodging a value trap at Pearson, as we said last week, but fear we fell into one at M&S. Time to cut and run.
Questor says: sell
Ticker: MKS
Share price at close: 170.95p
Update: Zotefoams
A profit warning and share price collapse last week at Zotefoams, the specialist in lightweight foam sheet materials, reminds this column – yet again, unfortunately – of three harsh lessons.
First, we can all spot a good story, but it is the valuation you pay to access it that counts. In Zotefoams’ case, paying more than 30 times forecast earnings to get involved was a blunder.
Second, there are few worse investments than a growth stock that fails to deliver. Zotefoams’ share price plunge is evidence of that. Lofty valuations leave little or no protection against falls.
Third, operational gearing works both ways at capital-intensive businesses. Profits can rise sharply as big percentages of incremental sales drop straight through to the bottom line. They can also drop quickly if sales falter and this is what is happening now, in both Europe and North America.
All of this means we are keen to avoid being caught by another lesson, namely that profit warnings tend to come in bunches. Alas, Zotefoams adds to a gathering haul of profit warnings for this column and it is time to run away, just in case, even if this crystallises a nasty loss on our tip in February.
Questor says: sell
Ticker: ZTF
Share price at close: 336p
Update: William Hill
The all-share bid for Canada’s Stars Group by Flutter adds to a long string of deals in the gambling industry, which continues to consolidate as the leading players jockey for position to make the most of deregulation in America.
Questor still believes that William Hill has strategic attractions in this regard, thanks to its established presence in Nevada, links with Monmouth Park racetrack and relationship with the Eldorado casinos group.
- Read Questor’s rules of investment before you follow our tips
Regulatory pressure is not going to ease in Britain and patience will be needed, but the shares will look cheap if Hills achieves its goal of doubling profits by 2023.
Still worth a flutter.
Questor says: buy
Ticker: WMH
Share price at close: 189.85p
Russ Mould is investment director at AJ Bell, the stockbroker
Read the latest Questor column on telegraph.co.uk every Sunday, Tuesday, Wednesday, Thursday and Friday from 6am.