News that embattled high street chain Marks and Spencer Group (LSE: MKS) is in early talks about buying supermarket technology specialist Ocado Group‘s (LSE: OCDO) distribution and delivery networks has sent both stocks flying.
On your Marks!
There is one clear winner, though. While the move would finally allow Marks to make online food deliveries it offers a wider benefit for Ocado by confirming the attraction of its overall strategy and offering. Accordingly, Marks has climbed 1.83% in early trading but Ocado is up a tasty 4.48%.
It helps that investors have greater faith in Ocado, whose share price has soared by 275% to 988p over the last three years, a period in which Marks fell 30%. However, this has left the former looking overpriced, and the latter underpriced.
Food for thought
Marks is said to be in early stage talks about buying Ocado’s supermarket operations, including its automated distribution centres, delivery vans and part of its logistics network, as it looks to make a belated attack on the online grocery market. Better late than never!
Chief executive Steve Rowe been sceptical about the benefit of online deliveries as the store’s sandwiches, salads and ready meals are mostly treats designed to be eaten that day, and I can see his point. This doesn’t quite lend itself to repeat orders in the same way as the essentials people buy from Tesco, Sainsbury’s and so on.
So has Rowe caved into pressure from the City or is there a real opportunity here? Markets are cautiously optimistic as the move will give M&S a stronger delivery network and a new stream of earnings. Food is also the strongest part of its brand, so maybe it is wise to focus on this.
The group is now going through a serious overhaul, which includes a string of store closures. It trades at 10.7 times forward earnings and has a price-to-sales ratio of just 0.5, both of which suggest it could be a bargain. A forecast yield of 6.5% with cover of 1.3 is tempting, but earnings are at stall speed. It could make a nice turnaround play, but you’ve probably heard that before.
Food is a tough business as shoppers tighten their purse strings and high-street clothing is tougher still. Ocado’s plan to transform itself into a technology company instead looks prescient, and it has been successfully selling its expertise to grocers around the world.
It was the best performing stock on the FTSE 100 last year but many fear the excitement has now been overdone. Most of their concerns focus over whether it can justify its P/E valuation of a bewildering 5,799 times earnings and a heady price-to-book value of 23.93. Usually, I’d balk at buying anything above 20 times and 2 respectively!
Ocado is all about the future. It does not expect to make a profit this year as the relationships that are struck up with overseas suppliers such as US giant Kroger will take time to bear fruit. It is an exciting business, but also risky. Maybe Marks will be the real winner in the longer run.
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harveyj has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.