Today’s brief update from Ocado (LSE: OCDO) shows that the online grocery delivery company has delivered strong performance during the Christmas period. Gross sales for the 31 days of December were up 14.8% versus the prior year, which provides evidence that consumers are becoming more embracing of online grocery shopping, as well as showing that Ocado’s offering remains competitive in terms of price, convenience and service.
In addition to strong sales growth, Ocado is on target to record its first ever year of profitability. If met, this will be a major milestone for the company and could help to bolster investor sentiment in the short term.
A Challenging Future
Clearly, online grocery shopping is becoming a more appealing option for individuals and families, with one hour delivery slots and fewer substitutions making the experience more convenient and easier for customers. As such, it is evident that demand for Ocado’s services is likely to rise over the medium to long term as there is a gradual shift towards online grocery shopping.
The problem it faces, though, is the sheer volume of competition from rival supermarkets. This is causing the price of food to decline and, although it won’t necessarily mean that Ocado returns to being a loss-making company, it does mean that its lack of product diversification could hold it back somewhat.
Sector Peers
For example, the likes of Sainsbury’s (LSE: SBRY) and Morrisons (LSE: MRW) offer investors far greater diversification than Ocado. For instance, Sainsbury’s has an online grocery offering, but also sells a considerable volume of non-food items (such as clothes), has exposure to the fast-growing convenience store market, and is also moving into the no-frills discount sector via a joint venture with Danish firm, Netto.
Similarly, Morrisons is also moving into convenience stores at a rapid rate and, under the next CEO, it is likely that it will seek further diversification, since it has adequate resources to do so. Ocado, on the other hand, is only just forecast to turn a profit and is a pure play online grocer, which could leave it more exposed to further food price deflation.
Looking Ahead
While Ocado’s current valuation undoubtedly appeals (it trades on a price to earnings growth (PEG) ratio of just 0.9), its future remains highly uncertain. And, with it paying no dividend (and not being forecast to do so over the next two years), investors must rely upon capital growth only, which could disappoint somewhat as the online grocery sector becomes more challenging.
Although Sainsbury’s and Morrisons are not risk-free, they offer yields of 4.4% and 6.2% respectively (although it would be of little surprise for Morrisons’ new CEO to cut dividends per share) and, with additional diversification and greater financial firepower, they seem to be better positioned to come through the present challenges facing the sector and still generate a decent return for shareholders. As a result, they still seem to offer a better risk/reward profile than Ocado over the medium to long term.
