Ocado won’t deliver for investors: here's how to play it
Sales are surging at online grocer Ocado, but consistent profitability has proved elusive. The share price is heading for a fall, says Matthew Partridge.
One of the big winners from the restrictions induced by the pandemic has been the online food-delivery firm Ocado Group (LSE: OCDO). Faced with long queues outside supermarkets, people switched to shopping online. As a result, Ocado’s sales surged by 43.7% during the six months to 6 October and at one stage the group’s market value had more than doubled from its level at the start of this year, briefly eclipsing Tesco as the most valuable retailer in the UK. Even today it is up by 75% year-to-date. Despite this, I think it is heading for a fall.
The first problem with Ocado is that it is not very good at actually making money. It last turned a profit in 2016 and is forecast to increase its losses in 2021; analysts suggest that it may be 2024 before it starts generating cash. While part of this is due to spending on overseas expansion, if it can’t make money during conditions that are ideally suited to an online retailer, one has to wonder when it will. By contrast, traditional supermarkets such as J Sainsbury and Wm Morrison have still been able to make money this year, despite the extra costs associated with Covid-19. Tesco’s profits have risen.
What’s more, while the crisis has strongly boosted online shopping in the UK, this has only encouraged the large supermarkets to invest money and resources developing their online delivery arms, which benefit from the fact that they can select goods from their extensive network of supermarkets. As a result, despite its surge in sales, Ocado has lost market share in the online delivery sector this year. The entry of Amazon into online delivery, in the form of Amazon Fresh, which is already available in certain parts of the UK, is another competitive threat that could not only erode market share further, but also drive down margins, making it even harder for Ocado to turn a consistent profit.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
A tech bet
With the core operations unprofitable, Ocado is now pinning its hopes on being able to sell its delivery technology to supermarkets around the world in exchange for royalties. But agreeing deals has proved a protracted process and their potential profitability is uncertain, especially as they involve large upfront investment in warehouses. Nor is Ocado the only technology company in this field. It is also being sued in the US over possible patent infringement. Viewed in this context, Ocado’s valuation of 5.9 times 2021 sales seems extremely high.
With the shares down by 15% from their peak at the end of September, the market seems to be tiring of Ocado, so this is a good time to short the company at the current price of 2,259p, at £1 per 1p. Given the risks associated with shorting tech stocks, I suggest that you cover your position if it goes above 3,159p, giving you a total downside of £900.
Trading techniques: how debt affects stocks
Analysts are divided about the impact of issuing debt on a company’s share price. Some argue that it should have no effect, as while it makes the shares riskier, it also increases the potential returns.
Others think that the favourable tax treatment of debt (with interest payments at least partially offset against taxes) means that increased leverage should boost share prices.
Finally, there are those who claim that taking on more debt should be negative since it can be a sign that a company’s management is unable to use its existing resources effectively.
However, most studies suggest that issuing more debt has no impact on a firm’s stock, at least in the short term. A 1991 study by Dartmouth College covering 297 US debt offerings between 1980 and 1984, found that they had a statistically insignificant impact of -0.27% on share prices in the days following the announcement.
A more recent analysis by the University of Wisconsin in 1996, which examined 164 US bond issues in 1995, also found no statistically significant effect.
But this rule does not apply to companies that issue convertible bonds. As these bonds can be converted into shares if a company’s share price rises above a certain point, diluting existing shareholders, the market reacts negatively.
A 2012 study led by Eric Duca of Colegio Universitario de Estudios Financieros found that between 1984 and 1999 US companies that issued convertible bonds saw their share price fall by 1.7% when the issue was announced. Between 2000 and 2008, the reaction was more negative: the share price fell by an average of 4.6%.
How my tips have fared
This has been a good fortnight for my long tips, with four out of five of them appreciating. Media group ITV climbed from 95p to 100p, train and bus operator National Express advanced from 240p to 247p, pub group Mitchells & Butlers increased from 238p to 243p and Norwegian Cruise Line Holdings rose from $22 to $26.
The only exception was homebuilder Bellway, which fell from 3,112p to 2,885p. Overall, my long tips are now making a combined profit of £4,559, more than they were earning a fortnight ago.
Interestingly, my short tips have also done well, with three of the four falling. General Motors’s decision not to take an equity stake in electric-lorry maker Nikola has caused the latter’s shares to fall from $29.41 to $18.44.
Online health insurance firm eHealth also went down from $75.19 to $74.76, while online furniture retailer Wayfair also declined, from $256 to $236. The only share to buck the trend was social network Twitter, which advance from $44.94 to $48. Overall, my short tips are making a combined profit of £2,106, compared with £1,738 two weeks ago.
My nine open tips are making total profits of £6,665. I now have five long tips (ITV, National Express, Norwegian Cruise Line Holdings, Mitchells & Butlers and Bellway) and five shorts (Nikola, eHealth, Wayfair, Twitter and Ocado), which is a good balance.
With all but Twitter in the black, I don’t recommend that you close any positions. However, I suggest that you increase the stop-loss on Bellway to 2,725p (up from 2,700p) and do the same on both National Express and Mitchells & Butlers to 185p (up from 180p). My roundup of 2020 will be in the Christmas double issue, dated 25 December.
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.
He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.
Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.
As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.
Follow Matthew on Twitter: @DrMatthewPartri
-
How to invest in nuclear power
We need nuclear power to go green, says Dominic Frisby. But there is a better option than huge power stations
By Dominic Frisby Published
-
Chase slashes its easy-access savings rate – is it time to switch?
The Chase easy-access savings account has proved popular with savers thanks to its competitive rate and bonus deals. But, as the rate has dropped, has it lost its charm?
By Katie Williams Published
-
Harworth doubles profit as revenue soars – should you buy?
Harworth, a specialist property developer, is well-aligned with government policies, with revenue expected to rise by over 50% this year, and a further 30% the year after.
By Dr Matthew Partridge Published
-
Bitcoin miner Riot Platforms bleeds money – what happens now?
Riot Platforms struggles to make a profit and looks absurdly overvalued. Are troubles brewing?
By Dr Matthew Partridge Published
-
Intermediate options trading strategies: how to profit from them
Options trading strategies such as spreads, straddles and strangles can open new opportunities
By James Proudlock Published
-
M&S recovery has momentum: will it stick?
After years of decline, M&S seems to have turned a corner. But is this just a “dead cat bounce”?
By Dr Matthew Partridge Published
-
How to trade commodities using spread betting and CFDs
Commodities such as energy, metals and foods behave differently to stocks and bonds. Learning how to trade them can open up new opportunities to profit from volatility
By Eoin Treacy Published
-
0DTE options: should you bet on America's favourite?
Zero-days-to-expiration (0DTE) options are popular with US traders seeking high leverage, but consistent profits by betting on short-term market direction are slim
By Theo Casey Published
-
Spread betting for beginners: five trading tips
A short-term trading strategy can complement a long-term investment portfolio, but it can be costly for the unwary and reckless
By Dr Matthew Partridge Published
-
Is Alpha Group a good buy?
Alpha Group helps clients manage risks such as foreign exchange. After being promoted to the London Stock Exchange, does the stock still rally?
By Dr Matthew Partridge Published