Why M&S’ relegation from the FTSE 100 doesn’t mean the death of the High Street

Marks and Spencer (M&S) is set to be relegated from the FTSE 100 after the close of business today. This will be the first time that the company has lost its blue chip status.

The UK retailer was a founder member of the FTSE 100 and a stalwart of the UK High Street. But its share price has fallen 37% since the start of 2018 and is now at a near 20-year low amid online completion and falling sales.

M&S opened for business as a market stall in Leeds in 1884. “Don't ask the price, it’s a penny” was its slogan and by 1984 it had grown to become one of the UK’s 100 biggest companies.

There are now just 27 original members left in the FTSE 100.

Read more: How the FTSE 100 has changed

Marks and Spencer’s share price over the last 20 years

Source: Schroders. Refinitiv data correct as at 4 September 2019. Past performance is not a guide to future returns.

Jean Roche, Fund Manager, Pan-European Small and Mid Cap Team, says: “M&S is not alone among traditional bricks and mortar retailers when it comes to the challenges they face.”

“In the past, retailers have been able to be mediocre, but profitable. People now have much more choice, so retailers have to be smarter considering the competition posed by online disruptors such as Amazon and more nimble new competitors.

“Those that find a way to adapt will survive and prosper. Those that don’t will fall by the wayside.”

What is the FTSE reshuffle?

The FTSE reshuffle occurs once every quarter.

Companies are automatically promoted to the FTSE 100 from the FTSE 250 when they rank within the top 90 companies in the UK in terms of value.

Firms are automatically ejected from the FTSE 100 if they fall outside the top 110 largest companies.

Look beneath the headlines

The relegation of M&S to the FTSE 250 index is the latest in a long line of downbeat headlines for the UK’s High Street retailers. It has been the same for the last decade.

From the closures of Woolworths and HMV, to Debenhams and House of Fraser falling into administration, the obituaries for the High Street have long been written.

But amid the gloom there have been some rays of light. For instance, JD Sports, the sportswear retailer, got promoted to the FTSE 100 during the previous reshuffle three months ago.

How UK sectors have performed in 2019

You might also be surprised to find out that UK retailers have recorded double-digit returns this year (see graphic, below), which includes dividends as well as share price gains.

Retail is the seventh best performing sector in 2019, returning 16.9% up to 4 September.

This is more than the market which is up 10%, according to the Thomson Reuters UK Index tracker.

Beverages and healthcare lead the pack with returns of 25.7% and 22.6% respectively.

The auto sector is the worst performing, losing 46.4%.

UK sector performance in 2019 - year-to-date

Source: Schroders. Refinitiv data correct as at 4 September 2019. Past performance is not a guide to future returns.

Data for Thomson Reuters UK Sector Indices in local currency on a total return basis, which includes dividends, and not adjusted for inflation.

Retailers have endured a poor decade

This year’s performance should be put in context. Over the last ten years retailers have returned 2.8% on an annual basis.

That compares with the UK market which has returned 4.5% annually. The best performing sector – technology has returned and 17% a year.

UK inflation over that same period has been 2.7% according to the Bank of England inflation calculator.

That means returns adjusted for inflation, or “real” returns for the retailers has been 0.1% a year over the last decade, 1.8% for the overall market and 14.3% for the tech sector.

The relentlessly downbeat mood music from the media (and pessimism among analysts) appears to have filtered through to investors.

But is it confirmation that the UK consumer is in full retreat, and consumer-exposed sectors are in deep trouble?

Jean Roche sees plenty of reasons for optimism.

Specialist retailers shine through

“Some major bricks-and-mortar retailers have suffered sharp sales slowdowns, resulting in multiple profit warnings last year and this,” says Roche.

“But among businesses that are better adapting to the structural shifts reshaping the High Street, the news has been encouraging; many have capitalised on their competitors’ weaknesses.

“Companies such as homewares retailer Dunelm, pets supplies specialist Pets At Home and athleisure leader JD Sports have bucked the gloomy retail trend.

"They are all good examples of retailers giving customers what they want, coping well with the shift online and investing to improve customer experience.

"They are also benefitting from structural growth in their underlying markets, for example, in the case of Pets at Home, an increase in spend on pets.

“The promotion of JD Sports from the FTSE 250 to the top flight, just as Marks and Spencer, a FTSE 100 founding constituent, is rejected, encapsulates the changes underway in the retail sector.

"It also supports our belief that the odds of success are skewed in the favour of investors in UK small and mid-cap (SMID) companies.

“This is an area of the market packed full of companies taking advantage of new technologies and the internet to drive growth, disrupt and take share from sector incumbents.

"In a fast-evolving world, SMIDs are generally better able than large caps to capitalise on the opportunities as they tend to be more dynamic, and have a small base from which to achieve growth.

“The rise and demise of these two companies perhaps also serves to underline the importance of an active approach to investment.

"There has been a significant difference in performance between the best and worst retail stocks this year and investors who merely tracked the sector will not have been able to capitalise on this.

“Towards the end of 2018, a number of consumer-focused sectors, including UK retailers, “de-rated” significantly in excess of the wider market. In other words their shares fell sharply without any marked change in underlying earnings expectations as investors became concerned there could be further bad news to come.

“For a time dividend yields in high single digits were not unusual. In some instances they correctly signalled impending distress. This was certainly the case with Marks and Spencer, which subsequently re-set its dividend by 40%.

“The strong year-to-date performance by the sector as a whole suggests that investors lost some perspective earlier in 2019 (see Death of the High Street? Why we’re still backing UK retail).

"Also, perhaps, the standout returns of the best retail stocks tells you the market at times is simply unable to discern good companies from poor ones.

“Investors who stuck with the best companies have done particularly well, with Pets at Home, JD Sports and Dunelm being the three top performing retail stocks.

"They are up 105%, 77% and 63% respectively year to date (as at 30/08/19, total return basis, FTSE All-Share general retailers sector).

“Valuation discrepancies in the sector may not be quite what they were at the beginning of 2019.

"However, in our opinion there remain plenty of reasons to be optimistic about the outlook for the UK’s dynamic and innovative retailers.”