Spread betting – how is the UK’s supermarket sector faring?

Britain’s supermarkets have had a tough time the last few years, but there are signs that a focus on core operations is starting to pay off for some, while others face more fundamental questions. Results this week from Ocado and Morrisons offer some clues.

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Morrisons

 

Better-than-expected like-for-like sales saw Morrisons deliver a very positive set of interim results which came in ahead of forecasts.  Cutting prices is paying off as the company goes head to head with discounters.

Q2 like-for-like sales growth was stronger than expected at 2% and the third straight quarter of improvement. Pre-tax profit was 11% up on last year at £157m. Earnings per share grew nearly 12% and the company said it would raise the interim dividend to £1.58, to be payable to shareholders on the register on September 30th.

It’s another boost for CEO David Potts and his Fix, Rebuild and Grow strategy, which seems to be delivering on its focus on core promise. Indeed, sector-wide a focus on core seems to be the way forward for UK supermarkets that had become a little bloated after years of growth.

Morrisons is also continuing to deliver very strong cash generation, which means it can slash debt far quicker than expected. A £2bn free cash target has been achieved six months ahead of schedule. Unusually for a FTSE firm, it has been able to increase its pension surplus.

According to the firm, free cash rose 16% and it is on track to exceed its own cost savings target of £1bn next year.

The company is deleveraging and cutting costs well. And it’s in a better place than some competitors to weather the expected higher cost pressures caused by the weak pound as Morrisons sources more from the UK. Strategic partnerships announced with Amazon, Timpson and Ocado also put it on a strong footing for the future.

Investors seem to have responded positively to the improvement, with Morrisons stock trading at its highest level in over two years.  A long process of recovery, but recovery it is.

Ocado

 

It’s not quite the same story for Ocado, which delivered some OK numbers this week but has a number of challenges ahead.

A 19% increase in orders was impressive and it is building market share fast, outpacing the rest of the market. A deal with Morrisons has been re-engineered on a surer footing and we may expect further tie-ups with UK retailers off the back of this. Sales growth of 13% looks very healthy for an industry that is creaking, but there are some serious issues that need tackling to justify a P/E ratio of 150 times earnings.

Margins are the main concern as Ocado has reached its peak in terms of basket size, with average orders down to £107.94 from £111.75. With prices being cut by the big supermarkets, it’s hard to see how Ocado can improve on this any time soon. The firm said it sees no let-up in the bitter sector price war.

It is these concerns about margins which shook investors - Ocado’s shares have slipped by around one-sixth since the end of last week.

Meanwhile, Ocado has a looming fight with Amazon after the US giant launched headlong into fresh groceries in a move that threatens to completely disrupt the market. Ocado has been working alongside supermarkets, but Amazon Fresh is a direct pure-play competitor.

Ocado has been burning cash to gain market share at the expense of profits, and it is succeeding to grow.

But the problem is more fundamental. It’s questionable whether a pure-play delivery firm can work as a standalone business. Ocado picks, packs and delivers – nothing else.

Another factor weighing on the stock is the absence of a foreign tie-up. Ocado once again failed to announce a major deal with an overseas partner retailer, which it had promised to do by the end of last year.

Talk of a takeover is now doing the rounds. Rumours that Wal-Mart was interested drove the share price higher since it hit a trough at the end of June. Wal-Mart may prefer to turn Asda around first, but Ocado could be a complementary business for its UK business. Amazon might also be tempted.