Profit-takers hit Ocado after international breakthrough

It's by no means the final piece in the jigsaw, but Ocado's first international deal, confirmed this morning, is certainly an important milestone in building a compelling investment case. Still, scepticism around the online grocery retailer's future remains and its shares are weaker Monday.

News emerged Sunday that Ocado had signed an agreement with a regional European grocer to use its Ocado Smart Platform (OSP). The customer "wishes to remain anonymous until it launches its online business in order to retain [its] competitive advantage," we're told.

The partner will pay an up-front fee for access to OSP and an ongoing fee based on the volume of products sold online. Ocado thinks the deal will be earnings and cash neutral in the current and 2018 financial years, and "increasingly accretive thereafter".

However, the delay of at least 18 months before cash payback likely means a low net present value, says broker UBS.

Ocado chief Tim Steiner described the deal as "an exciting step in the evolution of our business", adding that: "Our discussions with other retailers across the globe are ongoing and we continue to expect to sign multiple deals in the medium term."

While broker Barclays describes the deal as "significant", it still has reservations. In particular, the fact that the client has not taken up Ocado's full package, which it argues "does not… really constitute an endorsement" and is not as positive a statement as it might have been.

Analyst James Anstead says the deal "does not carry quite the weight that we might have expected" due to the lack of detail. The identity of the counterparty was always likely to be the key point in its first international deal, he explains. Without knowing this, it's hard to draw any significant conclusions like the potential long-term size of the agreement.

"However, at the very minimum, we now have evidence that a grocery retailer has signed a deal with Ocado of its own free will – something that its biggest sceptics doubted would happen," Anstead continues.

Despite reading between the lines that further deals in the pipeline may carry more weight than this one, Anstead is not turning more positive just yet, re-iterating his 'equal weight' rating and 265p target price, still implying downside potential of 16%.

UBS is another repeating a negative stance, keeping its 'sell' rating and £2 target price. "Ocado technology is best-in-class and it has evolved a profitable model for online grocery in high population density areas as penetration plateaus," admits analyst Daniel Eckstein.

"To reach scale it will need to aggressively acquire customers through price and marketing investments. We expect OSP deals may disappoint high market expectations on value."

Rumours of an imminent deal with Marks and Spencer to run its online food offering saw shares shoot up almost 10% at the beginning of May.

Further details have yet to emerge, but Ocado shares are now up a quarter since the end of April. And it does have at least have a couple of cheerleaders in Goldman (target price 440p) and Credit Suisse (410p).

The news sent shares up as high as much as 8% early Monday before profit-takers piled in to bank gains. They traded as low as 303p at lunchtime.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.