Is Ocado worth a punt?

13th July 2010

It is dark times for retailers, we are told.

Share prices have slumped as the market anticipates the double blow of VAT rises and public sector job cuts. Take poor old Debenhams, now trading at a mere 6/7x earnings, with not a friend in the world as the market expects earnings to slump over the next couple of years. 

Even retailing stalwart Tesco is coming under some pressure over executive remuneration and long-term growth prospects.

Although there was a more upbeat take on the BBC's site, saying a sunny June which prompted retail sales last month tio grow at their fastest pace since March.

Back to the doom and gloom though, and Ocado has borne the brunt of the distaste for retail. The Ocado flotation has polarised views in the market. As this article in the FT shows, the City is divided, into those who believe the online grocer can change the face of retail, and those, like Schroders head of UK equities, Richard Buxton, who says simply: "The company needs the money".

Although the business has some undoubted pressure points, it is difficult to remember a float being subject to such forensic scrutiny.

M&S reports group sales in the 13 weeks to 3 July ahead by 4.4%, has a dividend yield of 4.57% and yet its shares still can't keep pace with the wider market, as this article on the BBC site shows.

They are some 15% behind the FTSE All-Share over the past year, approximately in line with the wider general retailers sector.

But is this market's pessimism justified?

The market's current assumption is that nothing will emerge to fill the void created by public sector job losses.

Whether this is true depends on whether you believe that growth in the public sector has prevented other sectors of the economy from flourishing.

This has caused some lively debate on the Motley Fool boards this month. Take BertEEE's view about the potential 700,000 lay-off in the public sector: "(Labour has) come up with the idea that private sector employment must gain 2m jobs in order to hit the OBR forecasts.

"This is 'impossible'. But of course, as we can see it was perfectly possible between 1995 and 2000 by following policies that were designed to encourage private sector employment."

richasdotcom counters with the view that soaring global growth in 2000 made such expansion in employment possible. The current global weakness suggests this is unlikely to be repeated.

Of course, there is no doubt that the VAT rise will act as a drag on consumer spending in the long-term, even if there is a short-term boost ahead of the rise.

But is it likely to create a drag effect higher than the price rise it generates? Surely, the hit of the VAT rise is unlikely to be higher than 2.5%?

My suspicion is that the impact of public sector job losses on consumer spending is something of a red herring. Global growth is weak, but steady at around 4%.

During previous public sector cut-backs, the private sector has emerged to fill the gap. It may not resurge as strongly, but it doesn't need to do anything significant to exceed current pessimistic expectations in the market.

Reports of the death of the retailers have been greatly exaggerated.

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