Ocado is an online supermarket which allows customers to do their shopping online and have it delivered to their door, and has been soaring away from the market over the past 15 months – in particular after signing an agreement to distribute the produce of budget supermarket Morrisons.
A bullish update on trading last week raised the possibility that the company could finally turn a profit, having struggled to do so in its 11 years of life.
The stock is up 479.92 per cent since the beginning of last year, with most of those gains coming after the agreement with Morrisons was signed in May.
Performance of stock vs index since Jan 2013
Source: FE Analytics
However, the stock has begun to roll over in recent weeks, losing 18.62 per cent since 26 February.
The catalyst seemed to be a profit warning from Morrisons, which has thrown the sector as a whole into turmoil.
There were a number of significant sales of shares by directors, usually seen as a bearish signal for a stock.
First Jason Gissing, co-founder of the company, left his role as commercial director and cashed in £15m of shares.
Then Douglas McCallum, a non-executive director, cashed in £346,000 worth of the stock.
Ocado’s share price has continued to suffer despite a positive trading update on Wednesday which showed a rise of 22.6 per cent in gross sales, reported before costs.
Source: FE Analytics
The figures reflect an increase in revenues from the tie-up with Morrisons, and have led analysts to project the company could make a £17.5m profit before tax this year, up from a £5.1m loss last year.
The company made £1.3m in 2012 and lost £2.4m in 2011.
Andrew Wade, analyst at Numis Securities, says that the results show the potential that the company has to leverage its presence online.
“In terms of forecasts, we leave our estimates unchanged and, despite the strong run in the shares, retain our positive stance, seeing huge long-term potential as Ocado benefits from the ongoing shift online, leveraging its market-leading IP to support Ocado Retail and develop partnerships with global grocery retailers,” he said.
Wade sees Ocado’s strategic shift to provide services for other retailers, facilitating their development of an online service, as a strength. He also highlights the shift in retailing online as a major tailwind for the company.
However, it is not clear that food retailing will be able to make this shift successfully.
Clive Black, analyst at Shore Capital, said: “These are especially interesting times for Ocado because the business is less free standing. There is now a new retail sub-sector emerging in the UK that embraces specialist online retailers.”
“Such retailers are in high demand from international and domestic investors, for good reasons to our minds, because they represent the future.”
“However, we see a very considerable difference in the business make-up, model, performance and strategic outlook of the likes of Appliance Online, ASOS and Boohoo compared with Ocado. Not least of which is the ability to report a profit and show positive operational gearing.”
Boohoo and AO are recently launched internet retailers, with the former being a competitor for ASOS and the latter focusing on electrical goods. Both have had strong starts to trading.
Boohoo launched on AIM last week and jumped 54 per cent from its IPO figure, while AO jumped almost 25 per cent. They have launched into a market that can’t get enough of internet-based stocks and tech in general.
Some managers in the sector have even warned that there could be a new bubble inflating.
Sooner or later, stocks driven higher on the back of their potential for growth over the internet have to justify that potential, and Black warns that future profits could be hard to come by.
Quindell is another tech firm yet to turn a profit that has been driven up on hopes of future growth, as FE Trustnet heard this week.
Investors have certainly been pushing up the price of Ocado in expectation of those future profits, betting that the company’s business model will eventually bear fruit.
Black disagrees, criticising “the total failure to generate profits and still derisory returns through centralised fulfilment of multi-temperature products to a fragmented customer base”.
“We remain convinced that this model will not work and that in time there is a greater likelihood than not that both Waitrose (John Lewis Partnership) and Morrisons will walk away from Ocado; note that Waitrose's in-house online grocery capability is growing at a rate in excess of 60 per cent year-to-date,” he said.
“We remain of the view that Ocado is a distinctive business model,” he added. “More fundamentally, we remain of the view that Ocado is a distinctive business model in that it doesn't work when it comes to earnings.”
“The present share price remains anomalous to our minds and the read across to other highly rated online retailers is spurious in our view.”
“No doubt Ocado is talking to other retailers about being an online management consultant but that is very different from being an online proprietary retailer.”
James Thomson, manager of the Rathbone Global Opportunities fund, is a manager who has taken big positions in other internet-based stocks such as Rightmove.
Thomson says that he too is unconvinced it has a scalable business model as an internet stock.
The company is able to successfully build a client base from the internet, but managing the cost of packaging and driving to people’s homes distribution-wise, it doesn’t benefit it to operate in this way, he warns.
The case for all retailers operating online is different to food retailers such as Ocado, for whom it is much more expensive to distribute perishables and chilled foods.
Thomson describes the recent share price rise of Ocado as “the biggest short squeeze in UK history”.
A short squeeze occurs when a heavily shorted stock is driven higher, forcing investors who are short to sell to close out their positions, ironically driving the stock even higher still – for a while.
Black adds that the brooding price war in the supermarket sector bodes ill for Ocado, and was referred to in the company’s trading update as a competitive market that could weigh on returns in the near future.
“With Tesco upping the ante on price and seeking to lower promotions, and Ocado price-matching Tesco (but not its promotions), there may be grounds to harbour concerns about the robustness of the online specialist's gross margin going forward,” Black said.
“Indeed, if Morrisons decides to turn the pricing screw a notch further, as widely speculated in the trade press, then that gross margin pressure may mount; hence we understand the relatively cautious outlook comments from the company about a competitive market.”
