Does 14% sales growth make Sports Direct International plc and Ocado Group plc a buy for 2017?
Shares of troubled retailer Sports Direct International (LSE: SPD) fell by 8% on Thursday morning, after the company admitted that full-year profits are likely to be "at the lower end of expectations." Internet grocer Ocado Group (LSE: OCDO) was also lower as it revealed strong sales growth, but failed to provide an update on expansion plans.
Both companies reported sales growth of about 14%. In this article I'll explain why this isn't enough to satisfy investors. I'll also consider the outlook for each stock in 2017.
Why are profits crumbling?
Sports Direct says its aim is to become the Selfridges of sports retail. Founder Mike Ashley is hoping to "elevate our sports retail proposition over the medium-to-long term." This strategy may explain why the group is investing heavily in both property and acquisitions.
However, this ambitious goal is of no help to shareholders today. The weaker pound meant that the cost of goods produced in Asia and priced in US dollars rose sharply during the first half of the year. Although reported sales rose by 14.2% to £1,638m, the group's underlying pre-tax profit fell by 57% to £71.6m.
This collapse in profits was largely caused by the sudden shifts in the exchange rates between the pound, euro and US dollar seen since the EU referendum. Sports Direct didn't have hedging in place to protect profits, and the group's attempts to hedge since then have been at less attractive rates.
However, things may not be quite as bad as they seem. Reported in pounds, the group's international sales rose by 66% to £330m during the first half of the year. Gross profit from international sales rose by 45% to £131m. This helped to offset the 5.1% fall in gross profit seen in the UK.
I estimate that Sports Direct shares trade on a forecast P/E of about 15 after today's news. But the company warned today that it still faces a number of medium-term challenges. Sports Direct could be a contrarian buy at current levels. But I'm not sure I understand enough about the group's strategy and outlook to make that call.
I'm certain about this stock
I don't have any doubts about Ocado. The internet grocery retailer said today that total group sales rose by 14.5% to £436.8m during the 16 weeks to 27 November. The average number of orders per week rose by 17.6% to 241,000 during the period, but the average order value fell by 2.9% to £105.61. The company didn't provide any new guidance on profit, suggesting that broker forecasts for earnings of 1.78p per share remain in line with management expectations.
This highlights the big problem with Ocado as an investment. The shares trade on a forecast P/E of 156, falling to a P/E of 116 for 2016/17. The company's sales keep rising, but the need for each order to be picked, packed and delivered means that costs also keep rising.
Ocado's £1.75bn market cap reflects hopes that the group will find another major supermarket customer for its technology. But so far these hopes have come to nothing. Ocado shares have lost 31% of their value over the last two years. In my view, further falls are likely.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Sports Direct International. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.