Shareholders of Ocado (LSE: OCDO) must certainly be thinking things can?t get any worse after the past three years in which they?ve seen the value of their holdings drop more than 50%. But I reckon there?s a good reason the company is the most shorted in the UK and that worse is to come for the online grocer in the years ahead.
My main fear is that as competition increases, Ocado will be stuck in a death spiral of needing to attract new customers through discounting, which leads to falling margins and will hinder the company?s ability to ever deliver considerable…
Shareholders of Ocado (LSE: OCDO) must certainly be thinking things can’t get any worse after the past three years in which they’ve seen the value of their holdings drop more than 50%. But I reckon there’s a good reason the company is the most shorted in the UK and that worse is to come for the online grocer in the years ahead.
My main fear is that as competition increases, Ocado will be stuck in a death spiral of needing to attract new customers through discounting, which leads to falling margins and will hinder the company’s ability to ever deliver considerable profits.
The detrimental effect of this process is clear in its 2016 results. Even though it increased gross sales by 13.6%, EBITDA only rose 3.3% as margins contracted due to big promotional discounting to bring in new customers.
Unfortunately I see little chance of this situation reversing itself. While Ocado is growing quickly, so are the online operations of competitors such as Tesco and J Sainsbury, both of whom are targeting online delivery as their one big growth opportunity. The entry of Amazon and its own food delivery service in London likewise portends poorly for competitors.
I’m also disheartened by the company’s continued failure to sign a long promised distribution agreement with a foreign grocer. Management’s inability to find a partner willing to pay for Ocado’s expertise in distribution and sales does not speak well of the marketable value of these skills.
With margins falling, net debt rising from £7.5m to £56.2m year-on-year and competition increasing, Ocado is one share I’d steer well clear of.
Flying into danger
Also on my list of companies to avoid is package holiday operator Thomas Cook (LSE: TCG). The company has recovered slightly from a disappointing 2016 when terror attacks in Belgium, France and Turkey severely dented tourists numbers, but I still don’t see the stock taking off anytime soon.
This is largely because growth in the sector is constrained by slow economic expansion in Europe. In Q1 the company’s bookings were up only 1% year-on-year and the average selling price contracted by 1% over the same period. This is not a good set of figures for any company and shows that the European travel market is relatively stagnant.
Now, even if top-line growth is minuscule the company can grow profits by fine-tuning its operations and cutting fat. This is happening, albeit slowly, with gross margins rising 10 basis points to 22.1% in Q1 and underlying operating losses shrinking marginally from £50m to £49m year-on-year.
But with economic growth across mainland Europe being slow, online competitors increasingly attractive to young consumers, the lingering threat of terrorism or political upheaval in many key destinations and Brexit denting Brits desire to travel overseas, I won’t be buying Thomas Cook shares any time soon.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Amazon. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.