A 10-year pay squeeze could spell trouble for these big retail stocks

Marks & Spencer
Marks & Spencer

Our chance of retaining access to the EU's open market without allowing free movement of people seems increasingly remote, and that's surely going to harm our businesses.

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The prospect for workers' pay over the next decade is looking more and more grim by the day, after the Institute for Fiscal Studies has predicted a 10-year pay squeeze with real incomes set to be lower in 2021 than they were in 2008.

The more I reflect on the EU referendum outcome, the more I think of turkeys voting for Christmas. Still, I guess that's democracy.

And one thing I definitely would not be doing now is investing any money in shares that are dependent on discretionary spending.

A favourite, fallen

It seems like forever that Marks & Spencer(LSE: MKS) has been struggling to turn itself back into the growing high street giant it once was, and it really hasn't been managing it. The erstwhile favourite is simply failing to adjust to today's online-driven fashion market.

That was hammered home by first-half results delivered earlier this month, which showed yet more big falls in underlying pre-tax profit and earnings per share (EPS). Free cash flow fell, debt rose, and the interim dividend was pegged at 6.8p per share.

Analysts are forecasting a full-year dividend yield of 5.9% even against the background of a mooted 14% drop in EPS, but that would be covered only around 1.5 times by earnings and I see it as unsustainable -- for M&S's dividends to be sustainable long term, I'd be wanting to see cover of at least around two times, in line with historical levels.

Marks and Spencer has failed to grow its EPS over the past five years in a relatively benign trading environment, and the probable decade-long Brexit-driven brake on economic growth we have in store is not going to provide any respite.

The share price has plunged by 33% in the past 12 months, yet that still leaves the shares on a prospective P/E of over 11 -- and that's not bargain territory for a company failing to turn itself around. It's a bargepole share for me.

Not faring as badly?

Debenhams(LSE: DEB) shares are on a much lower prospective P/E rating, of just 8.3. Having said that, we've seen a big decline in EPS since 2012, and forecasts for a further 12% drop this year suggest the firm's struggles are far from over.

At full-year results time last month, Debenhams reported net debt of £279m. For a company with a market cap of £700m that's not insignificant, and it implies that the underlying business is valued closer to a P/E of around the market average of 14 -- nowhere near bargain territory.

For now the dividend looks set to yield 5.9% this year, but that's solely because the share price has lost 30% in the past 12 months and 53% since 2012's peak in October that year. In cash terms it's been flat at around 3.4p for years while cover has been declining.

The real downer for me is looking at Debenhams' goods and prices. I browse in my local branch quite often and it sells some good stuff, but the last time I bought anything there was several years ago -- because it's just too expensive. It looks to me like it's priced for those with pretensions to higher status, and that seems like a dying breed.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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