Ocado shares should soften like ripe avocados

<p>Ocado investors have pared back an early sell-off after its CEO gave further reassurances that it would sign a crucial outsourcing contract before the end […]</p>

Ocado investors have pared back an early sell-off after its CEO gave further reassurances that it would sign a crucial outsourcing contract before the end of the year, but its chances of doing so look balanced, at best.

 

 

The online supermarket seems to have placed less emphasis on its first-half earnings released on Tuesday, and more on prospects for a new contract with a large retailer overseas.

Why? Because, without a new deal of that sort, it’s clear Ocado would struggle to replicate the first-ever full-year profit it reported in February.

For the half year, the UK-based retailer reported EBITDA, its ‘core earnings’ measure, that was 6.1% above forecasts.

But by the full-year, if forecasts for the next half-year, which ends in November are correct, the 11.4% gain year-on-year seen in H1 will have evaporated and the supermarket would in fact face a fall in full-year earnings on the year of 5.6%, to £77.64m.

At the same time, total distribution and admin costs were 22.6% higher by the end of H1, Ocado said on Tuesday, with some of that down to an increase in “overhead…as we continue to invest in our platform”.

It also noted that a “recharge” of fees to its only major third-party client, Morrisons, with which Ocado signed an agreement in July 2013, lifted this portion of H1 revenues by 152% to £32.4m vs. £16.9m at H1’14.

Quite clearly the magnitude of this jump is going to be a one-off.

Which brings us back to why Ocado has again attempted to head investors off at the pass by portraying the prospects of a new ‘technology’ deal—its first overseas one—as very strong, if not imminent.

The online retailer first began trailing this angle in February, when it reported its first-ever full-year profit; albeit one of just £7m.

 

 

Even assuming such a new deal were to be inked; it could be expected to be similar, but it’s unlikely to be identical to OCDO’s 25-year, £216m package of agreements with Wm. Morrison Supermarkets.

For instance, it now appears less likely that any new partner would agree to remit as much as £8m per annum for R&D costs, as WM did in 2013.

After all, is Ocado saying its ‘Ocado Smart Platform’ is still in beta, or ready for a broad roll-out?

Neither does the ‘EBIT bonus’ ratio with Morrisons.com at 25%, seem pitched at a level likely to gel with global business royalty norms.

EBITDA seems a more common basis for application of the formula, for one thing, but in all probability the ratio would probably be lower.

Where do these risks concerning sustainability (Morrisons revenues), uncertainty (overseas contract) and food price deflation, which OCDO acknowledged the potential impact of in H1, leave the investor?

Well, if they bought at OCDO’s two-year lows, in October 2014, where they’d be, is sitting on a gain that is not far off the 100%-plus level, touched on Monday, despite the stock having given back a fair chunk in 24 hours.

The rise would still represent a tempting take when weighed against prospects for an elusive new tech deal, and on that basis, a correction is likely to ensue shortly.

The last time OCDO retraced to any great extent coincided with readings from my favourite indicator, the Slow Stochastic oscillator, which at the time had gone ‘overbought’, before crossing itself and inverting downwards, making for a share price loss of more than 10% during a fortnight in May.

A similar pull-back is favoured in nearby sessions.

But this is Ocado—your mileage may vary.

OCADO DAILY POST H1 2015 30TH JUNE 2015

Join our live webinars for the latest analysis and trading ideas. Register now

GAIN Capital UK Limited (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.

No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

For further details see our full non-independent research disclaimer and quarterly summary.