Investability bulletin 17/03/22: Ocadon’t

Food price inflation is putting the grocery industry under strain

Photo by Markus Spiske

Ocado shares were at the bottom of the heap in London as it became the latest to warn on inflation. “Significant increases in raw materials and product cost prices, energy, utilities, and dry ice through Q1 have added further cost headwinds for the grocery industry in the UK,” the pick-and-pack specialist warned in its Q1 trading update.

As I suggested a few days ago, we are going to see a lot of tepid guidance due to inflation, cuts to profit and margin forecasts because of the rise in input costs, higher interest rates and of course a bit of Ukraine-war-uncertainty sandbagging. Ocado says the scale of food price inflation over the course of this year, coupled with the overall level of market demand as the cost-of-living increases, is difficult to predict.  
“These uncertainties over inflation, which have increased significantly in recent weeks due to the war in Ukraine, the overall level of market demand, and the continued return to pre-Covid shopping patterns, mean that while easier comparatives, strong customer demand, and further growth in capacity, should see revenue growth end the year in the high-teens, the full-year growth rate may be closer to 10%,” management said today. “EBITDA margins will reflect the same key factors as those outlined in the Q4 Trading Statement, and may be further impacted by the significant increases in energy costs where uncertainty remains.”
In Q1, Ocado said revenue was down 5.7% in the quarter, up 31.7% v Q1 2020, against a challenging comparative and a 4% fall in UK grocery market sales. Still active customer growth was good, growing by 31% year-on-year to 835,000, with orders up 11.6%. However, average basket size fell 15% to £124, as customer behaviours return towards pre-Covid levels. 
Its shares declined more than 7% and are down 28% YTD, -46% over the last 12 months. When does the falling share price finally look attractive? 
Peak Greggs? A note from Edison Investment Research on Greggs says far from it and argues the company has demonstrated a strong trading recovery through FY21, which gave management confidence to accelerate its Next Generation Greggs growth strategy with the aiming of doubling revenue by FY26. 
They write: “The accelerated growth prospects reflect a combination of better opportunities in the property market due to COVID, helped by Greggs’ innovation in store formats, and pushing ahead with developing revenue in new channels and underpenetrated dayparts, which have trialled successfully. The growth will be supported by further menu development, where Greggs has a strong track record of innovation, and a greater focus on increasing customer loyalty. Our DCF-based valuation is £31.60 per share. 
The share price is trading at a discount of c 36% to our DCF-based valuation of £31.60, which assumes management achieves its ambitious revenue target of £2.4bn by FY26. The P/E multiples for FY22e (19.7x) and FY23e (19.0x) are at only a modest premium to its long-run average (17.9x since FY13) despite now offering potentially higher revenue growth (CAGR 15% through FY26) than historically (CAGR c 7% FY13-19, pre COVID-19).” 
Stocks in Europe were flat, struggling to hold onto early gains after a sharp rally for Wall Street in the wake of the Federal Reserve’s first interest rate hike since 2018. European indices rose mildly in early trade, after the S&P 500 finished the day up 2.2% following the decision by the Fed, having initially swung lower on the decision. Still, it looks like short covering rallies amid a longer-term bearish trend.  US 10yr yields trade around 2.150%, gold is around $1,940 and crude oil hovers around $99.
The median dot plot calls for 7 hikes this year to 1.9%…with members pencilling in 2.8% further out, which would take the fed funds rate above neutral. This constitutes a major change in Fed thinking, effectively ending what we might term the ‘Fed put’. However the question everyone is asking is whether they can stick to it. For what it’s worth I think they will get to seven for two obvious reasons: inflation is super-hot and showing no signs of slowing, and the labour market is in the words of Jay Powell, “tight… to an unhealthy level”. The Fed thinks they can tighten without impacting the labour too much – I tend to agree. Tightening will impact Wall Street more than Main St at this point…further down the line is harder to call – it could lead to recession. Another thing is that getting inflation under control is job one to scotch the ‘stagflation’ chatter. It was noteworthy that in a response to whether the Fed would be prepared to take the path it did under Paul Volcker and do whatever it takes to get inflation under control Powell responded in the affirmative.  I think the urgency is at last there, very late, and the market kind of liked that.
On QT, the FOMC statement simply said it expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities at a coming meeting. The curve flattened briskly – shorter end is more responsive to Fed policy moves of course. 2s to 2%, 2s10s spread down to 20bps. 5s10s inverted but is flat now. Can see 10s move sharply to 2.5% now and front end follows. There was a nod to Ukraine, saying the invasion will likely create “additional upward pressure on inflation and weigh on economic activity”, but there is no sense that the FOMC is slowing down because of it. 
The Bank of England is the main event for the markets today, at least in FX. GBPUSD trades firmer around 1.3180 this morning after bouncing off the 1.30 support. Dollar is a tad lighter post-Fed, sense that the FOMC has shown its hand and now it’s a sell-the-fact trade. The BoE is almost certain to raise interest rates by 25bps for a third consecutive meeting. Risks for the pound perhaps skewed to the upside as the MPC could vote for 50bps. 
Dislocation in markets…as mentioned yesterday there are signs of stress everywhere. Just look at some of the huge intraday swings on the Hang Seng, or nickel. Look anywhere and you spot signs of liquidity narrowing. Now the European Federation of Energy Traders called on central banks and governments to provide “emergency liquidity support”. The body warned that many were in a “position where their ability to source additional liquidity is severely reduced or, in some cases, exhausted”, and it stressed that “generally sound and healthy energy companies” might be “unable to access cash”. 
Headlines aplenty coming out of Ukraine-Russia peace talks – FT headline yesterday pointing to a 15-pt peace plan saw risk catch bid yesterday afternoon, but subsequent headlines and responses were a lot sketchier. Putin reiterated that Russia will achieve all its tasks but is ready for talks, but Lavrov was suggesting the two sides were nearing consensus on wording…we need to monitor. Oil prices are a bit higher this morning after sliding for most of yesterday. 

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