Royal Mail and Ocado's upside potential

These two blue-chips have had a grim few months, but there's still hope for both. Graeme Evans explains why.

Royal Mail and Ocado are two FTSE 100 stocks guaranteed to get investors talking. Whether it's Royal Mail's precarious dividend yield or the price of Ocado's shares, these are two blue-chips on which most have an opinion.

A couple of eye-catching equity research notes from Barclays helped to whip up the debate on both companies today, with the team valuing Royal Mail shares at more than 400p and seeing Ocado as now at a "reasonable" price.

The note on Royal Mail came on the day that shares in the letters and parcels firm fell 2% to within 15p of the 330p IPO price seen in 2013. This follows the dramatic October 1 profits warning, when new boss Rico Back cut the company's annual cost savings target by 56% to £100 million.

One crumb of comfort for investors, who include postal workers and thousands of small shareholders, is that Royal Mail allayed fears about the high-yielding dividend, which is backed by a strong balance sheet and cash generation.

Barclays sees the dividend yield of just over 7% as the main support for the shares until Back is able to set out how he intends to revive the business. A strategy update is planned alongside interim results on November 15, while there's also an investor seminar scheduled for next year.

Barclays said:

"Management now needs to demonstrate how it plans to achieve the new guidance and return the business to growth and over what timeframe."

In the meantime, Barclays has cut its price target from its previous 630p to 410p. This is still a potential upside of 21% against Monday's night’s price of 338p.

The forecast rate of dividend growth has also been reduced by Barclays from 5% to 2.5% for the 2019 results, although at 24.6p a share this still represents a target yield of 6% in line with the peer group.

In contrast, Gerald Khoo at Liberum expressed fears last week that earnings cover for the dividend is weak. He cut his price target from 415p to 250p.

At Ocado, Barclays thinks the stock is now reasonably priced just a few weeks after saying the "valuation overshoots likely reality". At that point, shares in the online grocer-turned-technology company were changing hands at almost £11, fuelled by a number of overseas grocers signing up for Ocado's logistics platform.

Despite little newsflow since then, shares have fallen back to below 800p to bring the company closer to the bank’s ongoing 875p target.

The share price fall also provided an opportunity this week for Luke Jensen, CEO of Ocado Solutions, to spend £100,000 on shares at an average price 790p, reversing the recent trend of director share sales.

Barclays said:

"We are always wary of reading too much into director dealings but clearly it is more encouraging to see purchases rather than sales."

The next event scheduled in the Ocado calendar is the Q4 trading statement on 13 December, before the full-year results in February. However, Barclays adds that an announcement regarding the finalisation of the company's partnership with US chain Kroger could come at any time.

The deal is expected to create as many as 20 automated Customer Fulfilment Centres in the United States, where Kroger is the country's second largest grocer.

Today's note added: "Although working with Ocado involves paying significant fees, it might also be seen as a 'best-in-class' solution and appear to be a lower risk option than 'going it alone'.

"However, it is difficult to gauge the size of Ocado's potential market and building tens of facilities internationally will likely bring practical challenges."

Peel Hunt analysts recently said Ocado's automated fulfilment technology had the potential to become the standard platform for retail logistics across all sectors, not just groceries. This was backed up by a target price of 1700p.