Ocado’s shares plunged after broker downgrade

It seems sometimes that Ocado just can’t get a break.

Battered by the fallout from the supermarket wars so far this year, the online retailer’s share price was on the way back up before a savage downgrade from broker Redburn today sent shares tumbling again.

Redburn was previously a strong supporter of the stock – writing in May that the market had “underestimated the scope of opportunity” and upgrading it to ‘buy’ with a price target of 500p.

Just three months later that price target has been slashed by almost half to 257p and the stock downgraded to ‘sell’ on a host of operational concerns.

In a detailed note, Redburn analyst James Tracey’s primary concerns are:

  • A lack of sales growth momentum, with Ocado’s value perception and Google trends deteriorating during a time of unprecedented challenges in grocery retail. Redburn expects sales growth to slow to 12% in the third quarter and sliced its full-year 2015 EBIT forecasts by 57%.
  • Ocado is trading at a huge premium to its online peers, suggesting fair value is much lower than its current level.
  • The company’s preferred measure of profit, EBITDA, is not the most useful yardstick of value and that excluding these accounting benefits Ocado has not generated positive EBIT and is unlikely to for some years.
  • The company’s technology is not as unique or valuable as previously thought.

The market was either spooked by the conclusions or agreed with them as Ocado’s shares tumbled 13.5% to 349.1p. Yesterday the shares had made a rare journey above 400p.

Redburn is not alone in its view that Ocado is overvalued. Analysts at Deutsche, Exane BNP Paribas and Jefferies all have a price target between 300p-330p.

But there is significant disparity in broker views, which seems to match the volatility of the stock itself. JP Morgan Cazenove is overweight with a target of 476p, while Numis and Goldman Sachs retain Buy recommendations with targets of 500p and 680p respectively.

Ocado’s rollercoaster share price seems to suggest investors are also struggling to understand what fair value on the company, which famously has never made a full-year profit, represents.

Ocado was trading at 330p at the end of August 2013 before leaping to a high of 624p in February. It then rapidly plunged 53% to 292p in mid-May as its online partner Morrisons’ sales floundered before recovering to close at 403.6p last night.

As we’ve previously discussed, there seems plenty of evidence to support the Ocado bulls and the bears. Ocado’s growth slowed in the second quarter and its supermarket rivals have aggressively cut delivery fees to shore up their share of the growing online market.

Conversely, there are those who think Ocado’s new customer fulfilment centre in Andover, Hampshire could be a game-changer (a group which previously included Redburn). The online retailer is hoping to significantly improve efficiencies through faster and more cost-effective deployment.

The slightly improved sales performance of Morrisons suggested in the Kantar Worldpanel data yesterday could prove to be a further plus point if sustained across its retail channels.

Ocado announces its third-quarter trading on 11 September. Both the company’s supporters and detractors will pay particular attention to the rate of sales growth and any signs of international expansion.