Why I'd dump these expensive retailers

Updated: 
Ocado grocery delivery vans

Shares in online retailer Ocado Group(LSE: OCDO) jumped in early deals this morning but have since given back most of their gains after the company reported a 12.5% increase in revenue for the 26 weeks to 28 May but a 9.4% decline in pre-tax profit to £7.7m. Management blamed higher costs as a result of the lower profit figure as the group opened a new customer fulfilment centre in Andover, Hampshire. Depreciation incurred for the company's share of mechanical handling equipment assets owned by partner, Morrisons also dented income.

Still, while pre-tax profit for the period fell, other operating metrics showed significant growth. Order volumes for the period grew by 15.6% to an average of 260,000 orders per week and the number of active customers increased 12.7% year-on-year.

Deteriorating balance sheet 

However, the one area where figures did deteriorate was the company's balance sheet. Ocado ended the period with cash and equivalents of £37.8m, compared to £52.7m a year ago, while net debt rose to £210.5m from £136.2m. 

And net debt will rise further in the months ahead. For the full year, the company has guided towards capital expenditure of £175m, most of which will be funded by a £250m bond issue and approval of £100m revolving credit facility shortly after the end of the reported period. Even though this additional debt will be used to fund growth, it is fair to say that such a hefty slug of new borrowing is worrying considering Ocado's outlook. Indeed, City analysts have only forecast a pre-tax profit of £11m for the fiscal year ending 30 November, rising to £15.3m for fiscal 2018 on revenue of £1.65bn. Based on these projections, analysts have pencilled-in earnings per share of 2.1p for fiscal 2018, giving a forward P/E of 311. 

Considering Ocado's ballooning debt and tight profit margins, this valuation looks rich and doesn't leave much room for manoeuvre if the company does not meet City growth expectations. For those reasons, I would avoid the company.

Mixed update 

Following yesterday's mixed trading update, I would also avoid J Sainsbury(LSE: SBRY). Even though the company announced in its trading statement for the 16 weeks to 1 July that sales rose by 2.3% excluding fuel, City analysts are expecting this growth to come at the expense of profit. 

For the fiscal year ending 31 March 2018, analysts have pencilled-in earnings per share of 19.2p, down 6% year-on-year and down significantly from the 2014 high of 32.8p. Based on these figures, shares in the retailer are trading at a forward P/E ratio of 13.2, a relatively fair multiple considering the group's steady growth. The shares also support a dividend yield of 4%, and the payout is covered twice by earnings per share. 

Yesterday's numbers show that Sainsbury's is no longer struggling, but at the same time, opportunities for growth are limited, and with this being the case I would avoid the shares for the time being. There are better opportunities out there.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.