Ocado 8217 s confidence lifts its shares

Ocado is the latest grocer to highlight the emergence of pressure in wholesale food pricing as a result of the weakness of the pound.

Confidence vs. urgency

The group’s comments about these “market pricing dynamics” are categorical and carefully framed, and rightly underline that further developments hinge on what happens next with sterling. More importantly, any impact in the quarter to the end of February appears to have been contained, given that Ocado’s gross retail sales rose at the same 13.1% rate as the prior quarter. However, the group’s cautionary tone on pricing signals that it expects to be just as prone to deleterious inflationary pressure as larger and more conventional grocery rivals.

Whilst Ocado’s business model, in theory, enables it to remain profitable at lower operating margins than would be sustainable for established large supermarket chains, that model is thrown into question if subjected to potential top-line erosion from negative currency effects.

Looming inflation heightens other risks to Ocado’s model in the current retail operating environment, making the protracted quest for an international technology licensing deal (now two years longer than was initially stated) all the more urgent. Fortunately, the group is “as confident as ever” that it will ink a new deal. We note though, that it no longer states a clear time frame over which it expects to win another contract for Ocado Smart Platform. It’s no secret that the lack of such a deal is the biggest weight on Ocado stock, which has drifted lower for three consecutive years.

Again, should the wait for an international deal continue for much longer, another often repeated assurance —reiterated on Tuesday—that it expects to outpace both online and overall grocery market growth, will also begin to ring hollow, as bigger, more aggressive e-commerce rivals, with deeper financial resources—particularly, though not solely Amazon Fresh—begin to make inroads in grocery retail.

Confidence will take you only so far

Regardless of our overarching pessimism over Ocado’s business prospects, its technical chart demonstrates some undeniable strengths , albeit we attribute this resilience largely to momentum rather than seeing it as fundamentally underpinned.  Even so, the shares have broken out of the downward channel in place since October. The removal of such a psychological restriction—similar to the breach of the triangular continuation pattern that formed between early-February lows to date—tends to increase the pace of price action, particularly for a high-beta stock like Ocado. It’s therefore not much of a punchy call to state that Tuesday’s breakout may have  room on the upside, though we have drawn a potential resistance line at the low of the day marking Ocado’s biggest drop since late June 2016, on 13th September 2016. Whilst the stock subsequently traded above the price, 273p, it did so for just two months, and the most recent test of the line—which resulted in the stock’s failure to overcome it—exactly 3 months after the low was marked, confirms its validity as resistance.

It cannot be ruled out that the shares can breach 270p-275p again in the fairly near term; note the Stochastic Oscillator is close to though not above its overbought boundary. However the presence of a 38.2% retracement interval and the frequent incidence of visible resistance around the region places limits on OCDO’s medium-term upside from here. We would even go so far as to limit Ocado stock’s gains for the year to no higher than its 326p peak on 7th September 2016. In our view, the fierceness of the selling pressure after that price was seen strongly suggests strong long-term institutional distribution (including short selling) at the level. Absent significant changes in Ocado’s current fundamental situation (particularly if it were to seal a major new technology licensing deal) we see a high probability that significant selling pressure will emerge again should the shares reach their early September 2016 prices in the foreseeable future.

DAILY CHART: OCADO

Source: Thomson Reuters and City Index / please click image to enlarge