UBS has conceded it got it wrong a year ago with its 'sell' recommendation for Ocado Group PLC (LON:OCDO) but remains bearish on the stock.
The shares have more or less doubled since the Swiss bank-initiated coverage on the groceries delivery outfit but UBS expects most of those gains to disappear over the next 12 months, although it has grudgingly raised its 12-month target price to 280p from 215p.
READ: Ocado shares dip as JP Morgan tells investors to ‘wait for a better entry point’
“We underestimated Ocado's ability to win share in a slowing UK grocery market and were caught off-guard by the market's bullish response to Smart Platform (OSP) deals with Casino and Sobeys,” said UBS in a mea culpa research note.
“We're increasing our target price to reflect progress in both the UK Retail and Solutions businesses, but struggle to see a scenario where cash flows can justify today's valuation,” the bank revealed.
Although it got blind-sided by some developments in the Ocado story, UBS retains its basic view that the UK online grocery sector has shifted to maturity more quickly than is commonly perceived.
Recent research conducted by UBS shows online grocery purchase incidence in decline, while year-on-year industry sales growth has only been 3.6% year-to-date.
On the plus side, it has been easier than UBS expected for Ocado to win share from competitors – it is currently growing around three times faster than the market – and it is not achieving this through price cuts or excessive marketing.
“Shoppers seem more loyal to the online channel than the online retailer,” UBS conceded.
The bank also professed admiration for Ocado's ability to improve its price point by around two percentage points in the post-Brexit inflationary cycle of the past year. This likely reflects the growing relevance of Ocado to suppliers, UBS opined.
UBS seems to be out of step with the market on Ocado's two recent major deals – the acquisitions of Casino and Sobeys – placing a much higher worth on them than UBS did; it values the deals at around £40mln apiece.
READ: Get Shorty: Ocado shares soar after another international deal, heaping pressure on short-sellers
UBS thinks the market is over-egging the pudding when it comes to the scalability of Ocado's smart platform (OSP) technology.
“Whilst marginal economics of future deals should improve (redeploying software solutions, 'bot' procurement), the current c.£2.0bn 'in the price' for OSP implies Ocado can sign deals equating to c.US$15bn of installed CFC [customer fulfilment centre] capacity, i.e. 25x Casino / Sobey's.
"That likely requires cracking the US market, but with Walmart and Kroger (the biggest national players) having recently committed to store-pick based expansion with existing service providers, new US OSP clients seem likely to be (less scalable) regional players,” UBS believes.