This blog gives you the latest topical news plus some informal comments on them from ShareSoc’s directors and other contributors. These are the personal comments of the authors and not necessarily the considered views of ShareSoc. The writers may hold shares in the companies mentioned. You can add your own comments on the blog posts, but note that ShareSoc reserves the right to remove or edit comments where they are inappropriate or defamatory.

Audit Market Shake-Up, Ocado on TV, and Judges Scientific Presentation

The Competition and Markets Authority (CMA) have issued their final recommendations to improve competition in the audit market after an earlier public consultation. This follows widespread concerns over the dominance of the big four audit firms, the lack of apparent competition on price or quality, and repeated complaints about the quality of audits following several big and small company failures. Audit firms seem to have got off relatively lightly if the CMA’s recommendations are implemented by the Government. Here’s a brief summary of the proposed changes:

  1. Audit firms will have to operationally split their auditing operations from their consulting operations. This is not a requirement to totally split their businesses but to have separate management, accounts and remuneration.
  2. Mandatory joint audits are proposed for large companies where a big four firm is involved, with a few exceptions. This will enable smaller audit firms (“challengers” as they are referred to), to increase their capacity and credibility.
  3. Audit committees of companies will come under closer scrutiny with the audit regulator having powers to mandate standards, monitor those standards and issue public reprimands where appropriate. But the latter is surely going to be a somewhat ineffective remedy to incompetent audit committees. The CMA have rejected the idea of an independent body to select auditors as proposed by John Kingman due to legal barriers to that change, although they suggest it might be worth keeping under consideration.

One interesting statement in the CMA’s report is this: “In light of the consultation responses, we are recommending a combination of joint audits for most FTSE 350 companies and peer review for others”. That is important because previously it was suggested that only large companies be covered by either rule.

The key question is whether this will improve the quality of audits, which is the major issue. I suspect not because more price competition might simply result in more bids at minimum cost with the result of cutting corners on the audit itself. Improved regulation is the key to improving audit quality. But improving competition by reducing the dominance of the big four is otherwise surely to be welcomed.

For more information on the CMAs report, go to https://www.gov.uk/cma-cases/statutory-audit-market-study#final-report . You can see what I said in my response to the original consultation here: https://www.roliscon.com/CMA-Audit-Market-Review-Response.pdf and ShareSoc’s response is here: https://www.sharesoc.org/sharesoc-news/consultation-response-competition-and-markets-authority-re-statutory-audit-market-study/

There was an interesting glimpse into the operations of on-line supermarket operator Ocado (OCDO) on BBC television last night (programme entitled “Supermarket Secrets”). It showed their automated warehouse picking system although the final bagging up is still done manually – however that might change in future. Ocado is of course different to other on-line supermarket operations who mainly pick from in-store stock whereas Ocado have only central distribution operations with no physical retail outlets. Apparently most supermarkets have lower profits on their on-line sales as opposed to their in-store sales because the costs of delivery are not fully recovered in delivery charges. There are also more replacement items when delivery is from local supermarkets rather than from Ocado’s system.

There was an interesting review of Ocado’s business by Ian Smith in an FT supplement a month ago under the title “Pick of the Bunch”. It covered how Ocado moved from being a favourite of short-sellers to one of the best performing stocks in 2018. The change has been brought about because it is now perceived as more of a technology company than a simple retailer. That’s because it is selling its automated systems to other companies. That includes sales to Casino in France and Kroger in the USA.

Ocado lost money last year and is still forecast to lose money in the next two. But I bought a few shares regardless recently. It is interesting to see how the shopping habits in our family have changed. My wife does most of our food shopping and used to go to our local Sainsburys supermarket a couple of times per week. She started to occasionally use their on-line service when she was unwell. But now she uses it most of the time for her big weekly shop with only occasional visits to the store. If the habits of other families change in this way, one can see supermarkets adapting to the Ocado model.

A more long-standing holding of mine is Judges Scientific (JDG). This is a company that is an acquirer of small scientific instrument makers, and as with all good companies the management has a strong focus on return on capital. An interesting breakfast presentation after the results announcement can be seen here: https://www.piworld.co.uk/2019/03/26/judges-scientific-jdg-2018-full-year-results-presentation/ . It explains a lot about how the company operates.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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