Cube Midcap Report (12 Dec 2019) – Danger for bulls and bears #OCDO #PZC #DC

Cube Midcap Report (12 Dec 2019) – Danger for bulls and bears #OCDO #PZC #DC

Good morning!

There are some minor political events today, but let’s try to put them to one side.

We have updates from:

  • Ocado (OCDO)
  • PZ Cussons (PZC)
  • Dixons Carphone (DC.)
  • Serco (SRP)
  • Balfour Beatty (BBY)

Finished at 2pm.


Ocado (OCDO)

  • Share price: 1210.5p (+1%)
  • Market cap: £8.5 billion

Ocado Retail Q4 trading statement

Ocado Retail is the 50:50 joint venture between Ocado and Marks and Spencer. Waitrose products are set to be dumped in favour of M&S in September 2020.

The change was previewed by The Grocer back in May:

This is a big deal at the affluent end of the market. It’s going to be fascinating to see how it plays out. Which is more acceptable to Ocado shoppers – giving up on the Waitrose food that has been core to their cooking lives, or giving up on the Ocado shopping experience that has kept them loyal?

Well, so far, so good for Ocado.

Q4 revenue growth (to 1 December) is +10.8%, in line with expectations.

And Ocado wants everybody to know that M&S will be superior to Waitrose:

Range review completed, confirming that M&S has substitutes at the same price or lower, and of the same quality or better, for the majority of those currently supplied by Waitrose (which represent just over 4,000 products out of the current total range of over 55,000). We also anticipate adding many more additional M&S lines to the range.

The CEO of the JV is “pleased” and says that collaboration with M&S is “working well”.

Logistically: there are new customer fulfilment centres in Bristol and Purfleet (additional to the primary centre in Erith, SE London). The warehouse that burnt down in Hampshire will be rebuilt.

My view

I’ve mostly been aware of this share as a shorting opportunity. According to shorttracker, there are still a few funds lingering here on the short side. 2.4% in disclosed short positions means about £200 million of these shares are now borrowed and sold.

Unfortunately for shorters, the capital markets are open to Ocado and it has no trouble raising fresh funds. Only a few days ago, it raised £600 million in a convertible bond offering (repayment due 2025). It had originally sought to raise just £500 million.

The coupon on these bonds is a paltry 0.875% for the junk-rated borrower.

So I wouldn’t want to short this share: it is unlikely to run out of funds any time soon. Without a catalyst for failure, it will continue to be a dangerous share for bears.

As for the long investment thesis, that’s also very hard to justify on the basis of its financial history.

Revenues are growing at between 10-15% p.a., but the price to sales multiple at the current valuation is in the region of 4.5x.

So it’s rated as if it were an exciting growth stock or a high-margin business, but the truth is that growth is quite ordinary and there is no evidence of strong margins yet. Profits have been small and short-lived, so far.  According to official forecasts, it will be loss-making through 2021.

So I would rather be short Ocado than long at the current valuation. But my favourite stance is on the sidelines, i.e. staying as far away from it as possible!



PZ Cussons (PZC)

  • Share price: 191.2p (-1%)
  • Market cap: £820 million

Trading update

Directorate change

This old favourite of Lord Lee issues a damp trading update, in line with recent weather:

Challenging market conditions across key geographies led to a decline in first half revenue and operating profit compared with last year.

The UK High Street is named as a particular problem, along with broader consumer uncertainty in Europe & the Americas.

Confusingly, the company says that market share grew in the UK, USA and Indonesia. If revenues are down but market share is up, I guess we are left with the conclusion that people are spending less on household products?

Asia Pacific and Africa both sound tough, with several reasons given for each.


A stronger second half is expected subject to no further worsening of the economic and trading environments across our key geographies. Full year revenue and adjusted profit before tax is expected to be modestly below the prior year on a like-for-like basis.

Nobody likes to see a H2 weighting. This one is predicated on things not getting worse – but I think it’s reasonable to think that the UK High Street is going to get worse. As for broader consumer uncertainty – who knows?

CEO – separately, the CEO since 2006 is now retiring. A shame that after 25 years with the company, he has to leave on a day when the company’s performance is a little disappointing:

“The Board would like to thank Alex for his lifetime of service to PZ Cussons. His commitment to the CANDO and Good 4 Business values and culture which make PZ Cussons so special and his tireless efforts to develop and grow the business in each of its key markets are truly appreciated, particularly during recent difficult years.”

While a successor is found the Chair of the Company, an investment banker, will become Executive Chair.

My view

I see value in PZC shares at their current level – I like the brands and their reputations and pricing power among consumers should be somewhat safe.

But it would be good to get to the bottom of the recent downturn. What’s happening to the brands right now – is it purely macro related, or are they losing any of their reputation and pricing power?

Adjusted PBT last year was £69.8 million, but the company also swallowed £32.8 million in exceptional items, mostly impairments of Nigerian and Australian assets. But the company also wrote off substantial costs to do with the “Group Structure and Systems Project”, and the “Group Strategy Project”.

I get nervous when I see vauge costs like this written off as exceptional, because I fear that everyday software upgrades and administrative salaries are getting lumped in – costs which aren’t going away, or at the least will need to be repeated every few years.

I’d love to be proven wrong about that. But PZC also had veery large adjusting items in the previous year, FY May 2018, including £12 million in the “Group Structure and Systems Project”.

It’s time for the company to produce a clean set of results without large “exceptional” items. If it can do that, I’d be more interested in this one.


Dixons Carphone (DC.)

  • Share price: 140p (+6%)
  • Market cap: £1,630 million

H1 Interim results

This has been a difficult share for long-term investors. It is currently in loss-making mode, with only occasional flickers of optimism.

It reports a pre-tax loss of £86 million in these results, but all medium-term guidance is unchanged. This may have sparked today’s relief rally.

If you scroll to the adjusted EBIT numbers, broken down by division, you see that most things are going in the wrong direction. The major “UK & Ireland electricals” division takes a step backwards and the EBIT margin there is just 1.6% now (EBIT £31 million, revenue £1,979 million).

The International segment improved marginally, but “UK and Ireland Mobile” got worse. The CEO says:

Mobile is challenging as expected. As promised, this will be the trough year for Mobile losses, and it will be break-even by 2022.

The current year financial guidance is not too bad: the capex estimate is reduced (from £275 million to £200 million) as some spending is delayed. Adjusted net debt will fall, instead of staying flat (currently at £290 million, excluding lease liabilities). And the dividends lives to fight another day, as management continue to believe in the group’s potential.

My view

I’m not motivated to study this any further, as I don’t see a bright future for this company’s shareholders.

Personally, I do visit my local Currys from time to time, as I enjoy walking around and looking at the gadgets – the keyboard I’m typing this to you on now, was purchased in Currys earlier this week.

For higher-value items, however, I buy them direct from the manufacturer (e.g. my Google phone) or I buy them online, refurbished (my desktop computer).

The margins in this business aren’t worth fighting for, in my view.



Serco (SRP) also issued a positive trading update, including 10% organic grwoth in H2, driven by a few large contracts and extensions/rebids of existing contracts. The outlook for 2020 is in line with expectations.

Operating margin here is around 2.5%, meaning that profits are vulnerable to “small percentage changes in revenue and costs, as well as currency rates” (the company’s own words).

Balfour Beatty (BBY) was also positive. Revenues this year are up 5%, and profit is “slightly ahead” of expectations, albeit broadly in line with the prior year. Operating margin here is also in the region of 2%. As a general principle, I’m looking for higher-margin business than this to invest in.



That will do it for today. Roland will be back with another Midcap Report early next week. Cheers!



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