Belief had already been wearing thin for shareholders who reckoned that Ocado (LSE: OCDO) could avoid the pitfalls of the grocery industry price wars forever, but CEO Tim Steiner hammered the final nail in that coffin with his comments to investors in the online grocer’s latest trading statement. Steiner warned: “As the market remains very competitive, we are seeing sustained and continuing margin pressure and there is nothing to suggest that this will change in the short term.”
That’s undoubtedly a sentence no investor wants to hear, and so it’s little surprise that share prices are down a full 19% since. While management put out rosy statements about how the company’s intrinsic qualities would translate to long-term success, is there any reason to believe this optimism?
I don’t think so. Ocado is the most shorted stock on the LSE for good reason. While it’s true that customer satisfaction is high for the grocer, shown by survey results and continued double-digit growth in sales and order volumes, last year’s operating margins of 1.9% illustrate the razor edge Ocado is perched on.
The company long planned to prioritise market share growth at the expense of profits before eventually raising prices enough to create higher sustainable margins. However, with even management now questioning its ability to achieve this goal, investors should worry.
That’s because the industry is a cut throat one where traditional grocers are fighting tooth and nail to retain market share in the face of a sustained onslaught from German budget chains Aldi and Lidl. Online delivery, as the one fast growing segment of the market, has attracted the attention of all the major players, leaving Ocado a mere bit player without other business segments to fall back on.
With no apparent progress being made in sealing an agreement with overseas grocers, I don’t foresee a long future for Ocado as a standalone firm if current market conditions persist.
The Ashley effect
The return of much-maligned founder and majority shareholder Mike Ashley to the role of CEO has raised hopes for Sports Direct (LSE: SPD) shareholders that the discount sportswear king can reverse the 60%-plus fall in share prices over the past year.
Ashley will need to find success on several fronts. The first issue to tackle is turning around the core business. Interim results for the past half year paint a poor picture as like-for-like sales fell 0.8% and underlying pre-tax profits dropped 8.4% year-on-year. Now, Ashley knows the retail business so it wouldn’t be surprising if Sports Direct were able to turn things around in the coming years despite major changes in the way people are shopping for clothes.
However, I’m much less optimistic that necessary reforms will be made to address the second critical issue, the firm’s poor corporate governance. The problems at Sports Direct are rampant and include undisclosed related party transactions involving Ashley’s brother and the appointment of Ashley’s daughter’s boyfriend to head the company’s property team.
Combined with well-documented issues regarding poor labour practices and Ashley’s ham-fisted attempts to mollify critics, it’s no surprise Sports Direct is embroiled in a PR disaster. If Sports Direct’s only problems were falling profits, changing consumer habits and rising debts I might give the shares a closer look, but as long as corporate governance problems continue to plague it, I’ll be steering clear.