Some of the best returns come from buying shares that are deeply out of favour. Rolls-Royce is probably the best example, with the engine maker up 2,000% since the dark days of the pandemic in 2020. Not many on the whole London Stock Exchange can match that!
However, just because a share has fallen off a cliff, it doesn’t mean that I’m keen to start backing up the truck. Here are a pair of struggling mid-caps that I’m avoiding right now.
Ocado
Let’s start with Ocado (LSE:OCDO), given that the stock slumped 17% on Friday 12 September. This means it’s down 31% in the past month and 89% over five years. Ouch!
As well as its online grocery operation with Marks & Spencer, Ocado builds and helps run cutting-edge robotic warehouses for customers. Partners include Aeon in Japan, Coles Group in Australia, and Kroger in the US. All blue-chip names.
However, it was the last firm in that list (Kroger) that caused the share price damage this week. Its interim CEO Ron Sargent said the firm was doing a “site-by-site” review of its automated fulfilment network.
Kroger has eight sites live and a further two set to open next year. However, this news has sparked fears that more might not be in the pipeline, hurting Ocado’s international growth prospects.
This might turn out not to be true, while Ocado’s domestic joint venture has been doing really well recently. So perhaps this latest sell-off is overblown.
However, according to forecasts, the company’s losses are set to continue for the next couple of years. And with inflation and interest rates remaining stubbornly high, more supermarkets might pause their medium-term e-commerce expansion plans.
Given this uncertainty, I’m struggling to see a convincing investment case here.
WH Smith
WH Smith (LSE:SMWH) is in a different category, I feel. It has a proven business model and pays dividends from the profits that it regularly makes.
However, the reason for the share price’s collapse — down 50% in a year — can’t be ignored. Last month, the retailer announced that its North American operation had booked revenues from suppliers earlier that it should have done.
Consequently, profit in this division — its second-largest and the one with the most growth potential — is expected to be £25m this year, down from a previous forecast of about £55m.
WH Smith has called in auditing firm Deloitte to get to the bottom of things, and expects to provide more information alongside its full-year results in November.
If this proves to be an isolated incident and prior years’ results were not overstated too, then the stock could rally. It’s trading at less than 10 times this year’s forecast earnings, while offering a 4.65% dividend yield.
I also think the long-term growth story is intact. After selling off its high street operation, WH Smith is now a pureplay travel retailer, operating in trains stations, airports, and other travel hubs. These locations tend to enjoy captive audiences, face far less competition, and generate higher-than-average retail margins.
Of the two stocks, I think WH Smith is more interesting than Ocado right now. However, there’s just too much uncertainty with the accounting issues, so it’s one I’m also avoiding until the smoke clears.
