Up 20% in two months, how far can M&S go?

It wasn't too difficult to find flip arguments for Marks & Spencer Wednesday. In fact, it seems the high-street staple is a divisive stock, especially after the company's valuation swelled by a fifth in just two months, sending the shares to a one-year high.

We mentioned a month ago that M&S is one of the few stocks that attracts more 'sell' ratings than 'buys' and also pointed out last week that Investec analyst Kate Calvert thinks its recent performance has been "unjustified".

Still, the impressive run shows little sign of abating, with the stock racing to a fraction shy of 398p this morning.

And that's despite a 64% plunge in pre-tax profit to £176 million. Basic earnings per share (EPS) dived 71% to 30.4p on group revenue moderately higher at £10.6 billion. The annual dividend is held steady at 18.7p.

However, dig a little deeper and results beat expectations – albeit modestly, driven by good cost control and margin improvement. Better buying and less discounting meant gross margin in Clothing & Home shot up 105 basis points (bps) versus estimates of just 20-25bps.

And the profits plunge is easily explained by a doubling of so-called adjusted items to £437 million – shutting its UK defined benefit pension scheme cost £156 million, closing some overseas stores £130 million, and insurance mis-selling over £44 million.

Strip out those one-offs and pre-tax profit fell by a more modest 11% to £614 million. That's a 3.5% beat on company forecasts and 2% ahead of analyst consensus. International business was much better than expectations, while the UK was slightly weaker. EPS came in as a 4% beat.

A late Easter period did not help, either, falling outside these results.

Clearly, the firm's restructuring plan has impacted on profits, as CEO Steve Rowe pointed out, and, should it hit objectives you would imagine the firm will be in a better position for the future.

Rowe said he was pleased with the firm's progress and said the reduction of "excessive discounting" has helped return M&S to full-price market share growth.

We mentioned yesterday that income-seekers were out in force after a number of firms raised their dividends. Well, M&S has kept its flat, but it still yields a generous 4.7% and the balance sheet is improving.

Barclays analyst James Anstead thinks the payout is watertight on the basis that if Marks had needed to cut it, it would have done by now. "Strong cash generation" should also help it sustain that divi.

According to Anstead, the stock also trades at a discount to its sector average, with forecast 2018 price/earnings (PE) ratio at 13.3 times, compared to 15 times for peers. Sainsbury's is on 13.5 times and Morrisons on an expensive-looking 19.6 times.

That said, a target price of £4.10 isn't far off current levels, implying Marks is fully valued.

Elsewhere, Mark Photiades at Cantor Fitzgerald sticks with his 'sell' recommendation and £3 target.

The challenge for Marks now is to keep growing the popular convenience food business, and revive the women's clothes division. That'll be the job of Jill McDonald, currently running bike parts chain Halfords. She's M&S's new managing director, clothing, home & beauty from the autumn. Good luck.

She also has to contend with the increasing preference among consumers to shop online.

Indeed, we heard recently from David Jane, a fund manager at Miton, who explained the reasons why he was bearish on retailers – particularly the "bricks and mortar" brigade. A loss of market share is for that kind of retailer an obvious risk, despite a healthy-looking UK consumer.

"We have seen in the past how tricky 'bricks and mortar' retail can be when sales start to fall. The combination of high fixed costs and unsold stock leads to rapid margin declines and, when combined with high debt levels, the rapid demise of what seemed like large and successful businesses," Jane explained.

M&S needs to stay ahead of the curve in the longer-term, but the yield and any improvements from its restructuring plans could underpin the investment case.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.