M&S is a global clothing, food and home product retailer which is a member of the London Stock Exchange, currently listed on the FTSE 250 Index. M&S has recently suffered a loss in jobs and stores, both stemming from the pandemic, which took a crucifying hit to the consumer retail industry, but also tensions with war, inflationary pressures and recessionary threats. All combined have taken a toll on M&S' stock, which we believe is currently overvalued and will see further declines, hence our recommendation to short sell.
Current price: £124.37
Target price: £105.26
Stop: £134.65
Catalysts
We identify three major catalysts driving our recommendation as follows:
Cost of living crisis
It is impossible to ignore the effects of the energy crisis, which have crippled consumer budgets and increased the cost of living in the UK, Europe and globally. Being a multinational operator therefore, M&S has seen a considerable decline in sales across the board. As more and more savings are needed to fund energy bills, less can be spent on discretionary consumer goods.
We note M&S prides itself on high-quality, luxury foods and beverages, and therefore at a distressing time more consumers switch to discount supermarkets, exacerbating the impact for M&S.
JP Morgan's Georgina Johanan estimates a further 10% fall in consumer discretionary spending this year. Recent escalations with a full shutdown of Nord Stream 1's pipeline supply to Europe supports this estimate, and suggests further squeezes for consumers. As we approach winter months, we will see whether current gas storage levels (fairly high and promising) will be enough to carry through the whole winter, and what this means for 2023 supplies.
It does not seem inflation has peaked either, with the cost of living aside from energy bills also increasing. For July 2022 in the UK, inflation is 10.1% Y/y, with the anticipated August print releasing soon. High inflation is bad for M&S, as consumers reduce spending in times of higher inflation, and so we believe falling revenues will contribute to the fall in the stock.
Cross-currency headwinds
GBP/USD is one of the most traded currency pairs in the world. Recent economic situations have seen the greenback appreciating significantly, and has seen the GBP/USD pair fall. On Wednesday 7 September, the pair fell to $1.1406, the lowest level since 1985, driven by Truss' inauguration as PM. The EUR/USD pair fell below $0.99 for the first time since 2002.
What this means for M&S however, is that a weak pound and euro relative to the dollar makes imports expensive. Notably M&S will face higher cotton prices, its main import for clothing business, and continuations in the depreciation of the pound will mean further increases in import costs.
Supply-chain issues
As with major retailers, the biggest challenge facing them since the COVID-19 pandemic set is supply-chain disruptions. The fall in shipping activity crucially took a blow to M&S profits, but they have continued through the past two years especially given the emergence of the War on Ukraine in 2022. We believe these disruptions are likely to continue for the remainder of the year and into 2023, due to two main reasons: continuation of the war in Ukraine and China Zero-Covid policy means severe reduction in exports from China.
We have seen the effect that supply-chains and other headwinds have had on M&S this year, but also the effects on the wider indices are evident.
In Europe, retail is the worst performing sector, down 38% YTD (2022). In addition, in the UK the FTSE 350 Retailers Index has fallen 33% YTD (same period).
Risks
We can identify a risk we see to this trade as being the new measure by Liz Truss to impose an energy price cap. The proposition is to set a cap at £2,500 for the energy bill of all households, in place from 1 October 2022 for 2 years. This should help consumers save more, due to less energy bill obligations, and hence spend more on discretionary goods such as at M&S. This should increase the stock price.
However, we do not see this as a significant risk as of now. Truss has also said this money will be funded by windfall taxes, and also called for tax cuts, meaning the the Government will likely fall further into debt. The repayment of this debt will burden British citizens for years to come, and following the economic principle of 'Ricardian Equivalence', we may not see a major increase in consumer discretionary spending as expected. We note these measures are more to delay the inevitable recession than preventive of it, and so we remain cautious about the strength of the MKS stock.
We do not believe this sector will start performing well in the near-future, and so maintain our short positioning on a 6-month scale.