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03 December 2020

The Dichotomy of a Rally

As economists and experts scour through the alphabet looking for ways to describe the economy, I remain convinced that we are witnessing a K-shaped recovery; the polarity between success and failure in the UK market is vast.
 
On the one hand we have the Cineworld’s of the market; plagued by debt, in this case a cool £5.9bn, and at the mercy of a clientele hesitant to plump themselves in front of the big screens. The company has guided that admissions for the upcoming year will be, at most, 62% of last year’s level. More worryingly, under Cineworld’s “severe but plausible downside scenario”, loan covenants will be breached in December 2020 and June 2021. This, alongside the labyrinthine legal battle with Cineplex following the called-off merger in June, paints a ghastly outlook for the company. It is no wonder the shares have dropped significantly over the past year.
 
On the other end of the spectrum lies Ocado, the half-tech half-grocery juggernaut which just keeps powering forward. The group saw a 52% rise in quarterly sales, driven by the initial success of the tie-up with Marks and Spencer, where basket sizes have jumped by around five items since the switch out of Waitrose. While Ocado suffer a severe time-lag in trying to boost operational capacity, the renewed restrictions being imposed on the UK are sure to heighten consumer demand, driving orders per-week and order sizes to loftier levels. Furthermore, the news that Tesco, Britain’s largest supermarket chain, reinstated purchasing limits on household staples will further propel action amongst consumers, pushing sales further to the upside. Notwithstanding this, Ocado failed to generate a profit in the past financial year. But there is no need for investors to worry; the shares have still risen c.110% over the last 12 months.
 
Whether the market is overvaluing Ocado is a topic for another day, but the above depicts two businesses, in two different industries and with massively contrasting fortunes. One has a bright future ahead, while the other seems destined for further tribulations. This theme is a common thread running throughout the UK market; looking forward six months, there are clear winners and losers.
 
As further restrictions are imposed on the UK population, the Leisure, Hospitality and Travel sectors are facing a rocky future; the rule of six, fusing with the curfew and already-present social-distancing guidelines, will certainly curtail sales growth in pubs, bars and restaurants. Initially, the winner was seen to be the company which had the greatest access to outdoor seating, but with the winter chill now fully upon us, this has become all but a moot point. Now, industry analysts are looking towards the companies which take the smallest proportion of sales post-10pm.
 
The question which must then be raised is whether such companies can do anything to salvage their business and reputation. Adaption to the new normal is key, but surely Cineworld’s adaption would lead us to another Netflix, while for the travel and leisure industry, the only chance of sitting on the beach in the Bahamas is through a Virtual Reality headset. The digitisation of society is throttling the market into drastic changes.
 
People may look to blame Brexit or the government, but highly leveraged and poorly-run companies, operating in old-economy industries already at risk from organic progress, may have to take a long, hard look in the mirror. There is a real concern that investors are becoming reliant on the ever-growing government to bail-out those in need. ‘Big Government’ should be viewed as the exception which breaks the rule, rather than vice-versa. Therefore, with innovation and survival now ever-so-closely linked, some companies may need to wake up and smell the coffee before it is too late.
 
This article was taken from the Autumn 2020 issue of the publication, 1875. To sign up for our investment publications please visit www.redmayne.co.uk/publications.
 
Please note that investments and income arising from them can fall as well as rise in value. This communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned.
 
The Dichotomy of a Rally
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