Stockwatch: this FTSE 100 share could regain momentum

Shares have doubled since March, and upcoming results will put this blue-chip back in the spotlight.

Ahead of interim results next Tuesday 14 July, it is interesting to consider the valuation of FTSE 100-listed online grocery retailer and technology provider Ocado (LSE:OCDO), which some would see as Britain’s answer to Amazon (NASDAQ:AMZN). 

During February and March, the Covid-19 shock saw Ocado shares fall from around £13 to £10.80. Then, a realisation about how groceries shopping, in particular, was switching online, perhaps permanently, caused investors to chase the stock which more than doubled to £22.30. 

At £20 currently, Ocado is capitalised at just over £15 billion, despite looking some way off profitability, with the market valuation representing 8.6x last year’s sales of £1,757 million. By way of comparison, 37 stocks in the US Nasdaq index trade over 10x revenues compared with 30 in March 2000 – albeit this was the month before Nasdaq peaked and then fell 75% over the following two years.

A £1 billion fundraise on the back of a Spring re-rating

Ocado swiftly capitalised on its recent share price rally, placing £657 million worth of shares at £19.60, with convertible bonds making up the remainder of the £1 billion. It follows UK data showing online grocery sales doubling as a result of Covid-19, up from 7% to 13% of total sales, hence there is still plenty scope expansion and on a global basis too.

The placing was pitched at only a 5.7% discount to the prevailing market price of £20.79, implying high levels of confidence to accept only a modest discount after a sudden rise, and in the content of a £15 billion business expected to be loss-making over £150 million in each of the next two years. 

On a positive view, long-term prospects have re-rated due to the pandemic causing a permanent behavioural shift, and only 4.7% equity dilution has been incurred after the company was able to capitalise on the market’s optimism. On this view, Ocado is worth accumulating should its price succumb to market jitters anytime. 

Source: TradingView. Past performance is not a guide to future performance.

Is a “moment of truth” being deferred?

More sceptically, Ocado will never make profits like Amazon which has an octopus-like grip on a far-wider retail industry. Eventually, the stock will fall once profits reality is established, assuming that even happens, critics would say. 

By way of comparison, Sainsbury's (LSE:SBRY) and Morrisons (LSE:MRW) are each capitalised at around £4.4 billion, while projected to make around £450 million and £340 million net profit this year respectively. Ocado’s net loss is expected to reduce from £212 million to about £160 million this year.

It is also possible to reconcile the “status change” (of radical growth from online groceries) with a profits-based valuation approach, but be cautious about how this stock will end up in some extent of mean reversion in years ahead.

So, while Ocado has appeal as a momentum trade – online groceries being a rare spot of growth in a generally challenged economy, and confidence among shareholders manifestly high – the mood will inevitably cool in the longer run. 

Forced to re-consider my long-term stance

I originally drew attention to Ocado shares as a ‘long-term buy’ at 525p in January 2018, re-iterating the view at 800p that May. Two years or so ago, Ocado was the target of short-sellers, with around 20% of its equity out on loan. Yet, it appeared to me that there was an inflection point for an overweight short position versus major French and Canadian technology/warehousing deals being announced.

Since listing a decade ago, there had been a regular tussle between traders who saw Ocado shares as an over-hyped logistics firm, and those who saw it as a beacon for digital retail; a kind of technology licenser enabling retail partners anywhere in the world, to boost their operation.

Looking back to market values in January 2018, Ocado’s price/sales ratio was 1.9 versus 4x for Amazon. Currently, Amazon trades on around 5x sales, hence Ocado’s 8.6x certainly discounts plenty assumptions about future growth. Moreover, Amazon’s profitability is now ramping up, although its price/earnings (PE) is around 150x currently, down on 330x two years ago, as if its valuation defies a sense for mean-reversion once profits reality is shown.

Ocado’s profit point seems to keep getting pushed out, although in the current environment shareholders are doubtless content to back a narrative of continued expansion – to capitalise on behavioural change that the pandemic has offered.  

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I adjusted my stance to ‘hold’ a year ago at £11.50, saying it was best to take a genuine long-term view - circa 10 years – on Ocado shares and buy the drops. Such a stance appears vindicated, at least by way of share price performance, and the company “making its own luck” and being now able to capitalise on changed shopping behaviour. 

I remain conscious of risks for mean-reversion, however, if the kind of growth investors beginning to back Ocado lately see only a volatile-sideways chart, and begin to get edgy. This is why it is important to keep a closer eye on results reporting.

Guidance recently suspended due to Covid-19

It is a sign of the current optimistic times in markets, how Ocado has broadly sustained a re-rating, despite management suspending even retail revenue guidance due to uncertainties.

Evidence from the last trading statement at the 6 May AGM cited like-for-like retail revenue for the second-quarter to end-May up 40.4% after 10.3% growth in the first quarter.

“The number of items per basket appears to have passed its peak but remains high, as more normal shopping behaviours have returned…” 

All Ocado’s partners have seen high levels of activity - a legacy relationship with Morrisons has seen increased use of the Ocado platform, despite an exclusive arrangement being relaxed so Ocado can pursue relations with Amazon.

A Low Price Promise means matching specific products against key competitors, with vouchers sent to customers if their basket is more expensive than at Tesco.com. So, it is unclear what will be the upshot for margin in the medium term, hence any tipping point into group profit (by way of contribution from the retail side).

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Interest is going to focus on how a relationship with Marks & Spencer (MKS) evolves when Ocado swaps its 18-year partnership with Waitrose, plus the upshot for M&S when the arrangement kicks off from 1 September. Some 1,600 essential clothing lines and over 6,000 food products will be offered, which is 2,000 more than from Waitrose.  Proof is quite some way off, however.

Look to see the upshot for costs

Next Tuesday’s results will be interesting on the revenue front, in terms of where re-rated sales might be consolidating, although I’m chiefly interested to see how the costs profile is responding.

That the 6 May AGM statement was able to cite £1.2 billion cash and yet weeks later Ocado raised another £1 billion on the back of its share price rise, suggests the board is buckled down for a few more years yet of strong investment and “losses”. 

It won’t be in the results statement, but I’d stay aware of the liability for online shoppers to pay a green delivery charge which the government is currently examining.

On the “solutions” side of the business, it is already known how initial customer fulfilment centres were delivered to Groupe Casino, south of Paris in March, and one for Sobeys in Ontario, Canada was being tested from late-April in anticipation of roll-out. This includes Ocado’s unique pick-up and packing technology. So, apart from new solutions partners being added – justifying an immediate regulatory news announcement – the interim results’ narrative seems set just to affirm progress.

Superficially, there is a red flag by way of the CEO “selling” 2 million shares at £19.66 on 30 June, although this was a £39.3 million transfer within the family and I would not read anything adverse into it.

So, it is possible that Ocado once again gleams in the spotlight next Tuesday; that traders can scalp renewed momentum. Currently, the story remains strong, and the M&S project is enticement for the rest of 2020. Yet investors should mind valuation risks at over 8x sales. Hold.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.