Interactive Investor

Share of the week: Ocado keeps fanclub onside

18th September 2015 16:50

Lee Wild from interactive investor

In another rollercoaster week where the FTSE 350 finished little changed, the index was packed with decent performers. Three stocks stand out – brewer and takeover target SABMiller, upgraded miner Centamin, and online supermarket and delivery expert Ocado.

It's Ocado that sticks out, however, because it remains so divisive five years after listing on the stockmarket. This marmite stock has had City analysts in a tizz since the summer of 2010 when it floated at 180p. It made its first ever annual profit last year after 15 years of trying, and the shares are now 345p following an 11% rally this week in reaction to promising third-quarter results.

Retail sales grew 15.3% in the 12 weeks ended 9 August to £252 million as the number of average orders jumped to 190,000 a week. The rate of decline in basket size due to food price deflation also halved since the first half to 1.1%. "We expect to continue growing slightly ahead of the online grocery market," said boss Tim Steiner. Analysts also expect a first international deal for its scalable, modular Customer Fulfilment Centre (CFC) operation within the next few months.

Ocado shares have plunged by a third since July in the absence of an agreement and concerns about the possible impact from Amazon's plans to launch Amazon Fresh in the UK. "In our view, this is unwarranted - we would expect Amazon's entry to somewhat facilitate the online shift and would expect Ocado, by virtue of its leading customer service proposition (range, freshness, accuracy), to be a net beneficiary of this," says Numis Securities analyst Andrew Wade.

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Forecasts for the year to November 2015 remain unchanged, with Wade pencilling in pre-tax profit of £12.7 million and earnings per share (EPS) of 2.1p on revenue of £1.1 billion. 'Buy' he says with 500p price target. Meanwhile, Morgan Stanley initiated coverage of the shares this week with 'overweight' advice and 420p target.

But retail sector expert Clive Black ain't so sure.

"Ocado's stock in terms of valuation rating may have sunk from the outer reaches of the stratosphere to something just a little closer to planet earth over the last 12-18 months but it still retains remarkably high and unjustified multiples to our minds," says Shore Capital's long-term doubter, repeating his 'sell' rating.

The analyst estimates EPS of 1.8p this year and 2.7p in 2016 with no dividend to be declared "for the foreseeable future". On these estimates, Ocado shares trade on 180 times forward earnings. "Call us old fashioned putting the earnings multiple first, an EV/sales ratio of 1.88x and an EV/EBITDA multiple of 27.1x (we estimate a free cash flow yield of 1.75%).

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.