Revenues mean nothing if the company in question loses money with every sale made. While this may seem obvious, the high yield market has been reminded of this in a painful way over the last few months.
The company in question is PetSmart – a large American pet store operator. It recently borrowed a grand total of $2bn in order to purchase Chewy, an online pet retailer. Theoretically buying a digital retailer to capture customers moving online makes sense. But PetSmart’s acquisition of Chewy is negative for one very important reason – once all the operating costs are factored in, Chewy doesn’t actually make any money from the sales it generates.
While PetSmart’s physical stores have very healthy profit margins, Chewy’s are negative. In effect what PetSmart is doing in buying Chewy is gaining loss-making online sales as a way to offset the loss of profitable offline sales. While there is a chance that the business can cut costs and restore some of that ever-decreasing pie of profit, the odds are stacked against them.
In contrast one business that we can get excited about is the 100%-online grocer Ocado. Whereas PetSmart’s online acquisition is loss-making, Ocado’s online grocery business is highly profitable, with better margins than all of the listed offline grocers and a very strong structural growth story. On top of its own online success, the business is well-positioned to benefit from other supermarkets attempting to move online through its platform-provision business – which effectively allows other retailers to establish an online business without the huge operational headache that starting from scratch would entail. Morrisons are currently using Ocado for this, which has been successful for both companies.
Overall this is a story of fundamentals. One company is scratching around trying desperately to defend a crumbling offline retail empire by loading up on more debt and buying a loss-making online retailer, while another company has a steady and sensible long-term plan to expand its already highly profitable business even further.
When these two companies came to the debt market earlier this year, the choice was relatively easy for us. As shown below, the subsequent performance has borne out our thesis.