Time to get on the bandwagon and short Ocado?

Interesting news this weekend that leading retail analyst Philip Dorgan, who has been a perpetual sceptic of Ocada, has warned that the online groc is in “significant danger of breaching its banking covenants this year, owing to a toxic cocktail of a pile of debt and falling market share”. He described it as the “beginning of the endgame” for the retailer that delivers Waitrose and Ocado-branded groceries in its green-liveried vans.

“Standing alone against the largest retailers in the country with a pile of debt and falling market share isn’t sustainable … we believe that Ocado’s days as a public company are limited,” said Dorgan. “It takes only small changes to consensus sales assumptions for a breach to occur.”

The shares originally floated at 180p in July 2010 and recently trade at 71p, valuing the company at just under £400. The stock was also hit last week when UBS analyst Mike Tattersall switched his recommendation from “hold” to “sell” and lowered his price target from 110p to 51p. In the note Tattersall said that although a growing number of Britons are buying groceries online there was little evidence that a “tipping point of mass-market adoption is approaching”. In fact there were some signs, he said, that demand was slowing. Waitrose was, ironically given its deal with them, also emerging as a “credible threat to Ocado at the quality end of the market”, Tattersall said. UBS was one of the banks on Ocado’s float ticket two years ago which is interesting.

Chief executive Tim Steiner relayed in Ocado’s update at the beginning of summer that the internet grocer was facing “challenging and uncertain” trading conditions – potential codeword for imminent profit warning/capital raising.

It seems that Ocado was also not able to capitalise on the four-day jubilee weekend where most of its mainstream supermarket competitors enjoyed a surge in sales as all its Friday delivery slots tend to be fully booked. Dorgan said it was likely that the Olympics had resulted in a “tricky couple of weeks” for Ocado with “consumers favouring big shops and top up shops, rather than online”.

Ocado is investing £210m in a second distribution centre in Dordon, Warwickshire, which will increase its sales potential next year but many analysts view this as stretching its finances. In June its debt stood at £71.3m compared with £19.2m a year ago and some analysts warned the retailer had limited headroom in its banking covenants if trading deteriorated. To remedy the situation management could cut capital expenditure or ask shareholders for more cash. Question is would they be prepared to stump up and also what size of discount would be required?

A spokeswoman for Ocado said the retailer was in regular dialogue with its banks, which were supportive and aware that the construction of Dordon was on budget and on schedule. “We are satisfied that the existing facilities provide sufficient funding for the group to operate for the foreseeable future,” she said. Didn’t we hear that from JJB, PDX, HMV et al before…

The chart below looks to us like we may see a re-visit of the old lows at 51p in the next few months, possibly lower if they breach their covenants. Sure, the stock is oversold but if there’s one thing that bear markets teach you it’s that new lows beget new lows and Ocado is most certainly in a bear market.