Ocado nods at elephant in the room

Ocado sales continued to grow ahead of the grocery market average in Q3, though the differential isn't the main watch for investors.

Ocado meets Alexa

Even the web grocery pioneer nods at the elephant in the room in its update. The group notes it's the first to offer customers the facility to modify orders using Alexa, Amazon's talkative A.I. front-end. Nice to have and a neat way to mediate neutral concern about Amazon's incremental encroachment into Ocado's fresh produce patch.  Ocado has seen “no real impact” from Amazon’s expansion in the UK’s grocery market, its CFO said on Tuesday morning. For now that’s very plausible. The e-commerce behemoth has rolled out Amazon Fresh very slowly and over a narrow range of north, central and east London boroughs. No one believes it will stop there though. So the question of how well Ocado is defended remains one which management still needs to answer adequately.

Rating and reality

True, Ocado’s sales growth shows signs of stabilising. Total retail sales were up 13.1% to £312.7m over 13 weeks to late-August, faster than 12.5% growth in the first half. Order size continued to moderate as per long-term norm relative to promotional phase, but the effect is being neutralized by rising average orders per week, up 16% in Q3, from 15.6% in H1. At this rate, and factoring current obligations, compound average earnings are widely forecast to grow at a pace that would slightly outpace Tesco’s c. 20%. Not bad, if a still-eye watering forward rating of around 275 times is ignored. Tesco can be bought for 19 times next year’s earnings, a modest premium to the sector. And Ocado is clearly not Amazon, though the Internet giant’s valuation slightly lags its UK rival.

The divide

This is where investors divide on Ocado, opting either for faith or scepticism on its ability to come good on long-standing plans, or to unearth an overlooked means of traction. The group’s economical disclosure around the long-awaited technology deal sealed in June only lifts confidence to a limited extent, particularly as it was software only.  To be sure, there’s no way around the investment needed to ensure optimum capacity. The group’s third and largest fulfilment centre, around 100km west of the capital will cost the equivalent to 2% of 2018 Ebitda. That looks absorbable. But with an operating margin that’s erratic and often below the market, it’s easy to see why ‘execution risk’ is the first thing many investors thought on Tuesday. Absent a big technology ‘reveal’ of the kind investors had initially been guided to expect, at best, Ocado shares should hold the erratic 260p-340p range since June into year end, but no better. Investors want more plausible long-term defences.

Trashy technicals

Technically speaking, the main worry for chart watchers now is Tuesday’s bearish-looking triangle breakout. Whilst not necessarily indicative—note price had snapped back within the converging range by the time of writing—the move appears to trash hopes that stabilizing sales would lead to more stable shares. 38.2% of the Brexit vote bottom to September ’16 top continues to support. But it’s difficult to see that as sustainable. More likely, the stock’s unusual sojourn above its 200-day moving average, a key threshold by which investors judge an assets long-term torn, is coming to an end. If so, the aforementioned Fibonacci retracement will be an early warning. If our short-term view is incorrect, we would expect OCDO to demonstrate its resilience by tagging August-September highs topside of the triangle, say at least 310p. We see that as unlikely in the final quarter.