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2 FTSE 250 mid-caps I’d sell in February

It wasn’t so long ago that online-only grocer Ocado (LSE: OCDO) was fêted in the City as the next great disruptor to shake up stodgy old industries and reward shareholders as it did so. But, since going public in 2010 Ocado’s share price has underperformed the FTSE 250 index by more than 25% and this trend is only getting worse. And with the company now facing increased competition and margin pressure that’s unlikely to change, I reckon shareholders should cut their losses and sell shares.

The worst part of Ocado’s struggles is that the company does offer a compelling product. It forced traditional grocers to change their business plans and seriously contemplate the idea that consumers would order groceries online and have them delivered to their home. Ocado’s continued popularity is evident in the 13.9% year-on-year increase in active customer numbers and 14.8% jump in revenue it recorded in fiscal 2016.

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Unfortunately, increased competition from the big four grocers and the recent introduction of Amazon Fresh into the market have re-created the price war that decimated profits in the traditional grocery market just a few years ago. We see this in Ocado’s EBITDA margins falling from 7.3% in 2015 to 6.6% last year. It’s hard to believe this trend will reverse as deep-pocketed Amazon seeks to entice customers to its Prime product and grocers such as Tesco and J Sainsbury exploit what is one of the few growth markets available to them.

Furthermore, with year-end net debt rising to twice EBITDA at £164.9m, Ocado lacks the balance sheet to continue a price war for years and years. With a long-awaited international partnership yet to materialise, shares trading at an astronomical 200 times consensus forward earnings and competitive pressures mounting, I’m steering well clear of Ocado this year.

Drowning in debt

With its share price up around 75% over the past year I would begin to think about taking my profits if I were a shareholder of African oil producer Tullow Oil (LSE: TLW). Tullow’s share price has risen so rapidly largely due to the rally in crude prices after they bottomed out at under $30/bbl in early 2016.

But with year-end net debt reaching an unsustainable $4.8bn and little reason to believe oil prices will soon break out of their $50-$55/bbl range, I think now is the time to reconsider owning Tullow shares. On the first point, Tullow management points to an expectation to be free cash flow positive with oil at $50/bbl as a reason that this debt level is manageable. However, if oil prices continue to trade around $53/bbl, Tullow won’t be generating the massive amounts of cash flow necessary for paying down debt.

Although daily production will be ramping up in 2017 due to the massive TEN Field off the Ghanaian coast coming on-line, I fear that if oil prices remain subdued in the near term, Tullow has little hope of quickly paying down its massive pile of debt. This will constrain shareholder returns and future growth by limiting exploratory capex budgets. If I were a risk-averse Tullow shareholder now might be the time to cut and run.

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Ian Pierce has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Amazon.com. 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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