Stock of the Day: Ocado Sellers won’t like these Apples

Another deal

Ocado buyers had another chance to taunt sceptics with a “how do you like them apples?” on Monday. The online grocery pioneer unveiled its second international partnership within six months, this time with Canada’s second-biggest food retailer, Sobeys. The deal will see Ocado develop and run an e-grocery service for Sobeys built on Ocado Smart Platform.

Credibility returns

Recent news has strengthened investor confidence in Ocado, after a long stretch in which it strained credibility and shareholder patience. The shares became one of the most shorted on the London Stock Exchange following failure to live up to early-2015 claims that it would soon sign new deals like the one it has with Morrisons. It did eventually ink another deal—about 18 months later.

Shorts are holding not folding

Still, news flow has enabled the shares to recoup, since November, about two-thirds of value lost from their all-time high in February 2014. Another 20% jump on Monday points to an even tighter squeeze on short sellers. FCA data still shows Ocado among the Top 5 most shorted shares.  Continued strong scepticism even in the face of new partnerships shows that the remarkable divide on Ocado amongst the investing community is intact. Sceptics note that the new partnerships will be earnings-neutral till at least 2019. Start-up costs will erase up-front fees. The Sobeys deal will also require additional capex of £15m in 2018/19, and “in future years”. Furthermore, Ocado has not timed or quantified profitability on either of the recent deals.

Cash burn continues

These deals will therefore be immaterial for 17/18 earnings that will be reported on 6th February, with consensus on core earnings forecasting an 11.5% rise to £90.6m. Ocado’s cash position would still be £74.8m in the red. Pre-tax profits will slide to £4.7m from £12.1m, according to forecasts compiled by Ocado. In other words, the company is not yet a strong generator of cash or profits. On that basis, the volatility of the business of food retailing is an existential threat. Amazon, which is rolling out a fresh food offer in the same UK regions as Ocado, is another threat.

More share shocks seen for shorts

Even so, the shares spiked past their mid-July 2015 high of 478.5p on Monday. The signal move also took the stock through the 61.8% Fibonacci interval at 468.9p that has been closely watched by traders. That marker references the stock’s February-October 2014 decline. It’s worth noting that 468.9p-478.5p had posed resistance some 18 months ago. Momentum often accelerates when resistance break. However, with Ocado trading at 496.7p at last check, follow-through opportunities were dwindling. Momentum gauges, like RSI, also indicated Ocado’s current up leg was near exhaustion. With earnings just a fortnight away though, and consensus spread over a wide range, we would not expect the shares to ease very far. 478.5p-468.9p ought to support the stock now. In fact, the back stop could extend to 444p levels—2014/2015 spike highs—forming a support range. Sellers would need a major disappointment from earnings to see significant downside below the range.