Why are so many hedge funds betting against Ocado shares?

Investors have been increasing their bets against Ocado as the online grocer’s struggles to make a profit and speculation over its future persist.

It comes as Ocado finds itself on the brink of relegation from the FTSE 100 after six years, with its share price having almost halved since the start of 2024.

Ocado is now the second most shorted London-listed stock behind oilfield services group Petrofac, with 8 percent of the company’s shares held by investors betting against its value, the highest level in six years.

Among those with big bets against the FTSE 100 company are Kintbury Capital, D1 Capital Partners and BlackRock Investment Management, regulatory data shows.

Ocado Retail joint venture continues to underperform

A healthy profit remains elusive for Ocado, which reported a loss of £394 million for the 12 months ending in December and a loss of £581 million in the previous year even as its sales continued to rise.

Most of the problem lies with its Marks & Spencer joint venture, Ocado Retail. Making online supermarket shopping profitable has always been complicated due to the enormous infrastructure and logistics costs involved in building a sizable operation.

Many of these costs relate to the “last mile” problem: the expensive, inefficient and slow delivery of goods from the warehouse to homes.

Ocado has also suffered a slowdown since the end of lockdown restrictions that had boosted the online shopping sector, and its share of the UK grocery market remains low at just 1.8 per cent.

The company’s sales rose by almost a third to £2.33 billion in 2020, but annual growth slowed to 7.2, 0.6 and 9.9 per cent in the following three years respectively.

Its operating margin has plummeted at an average annual rate of -77.8 percent over the past five years.

Analysts wonder whether Ocado will ever turn a profit again, having only made three (pre-tax) since it was founded in 2000.

Guy Lawson-Johns, equity analyst at Hargreaves Lansdown, says: “Ocado has an amazing product, but the current uncertainty over when it will be profitable is fueling bets that the valuation will take further hits.”

He adds that “it’s not hard to see why investor confidence is declining,” given that the company is burning through so much cash while its capital spending levels remain high.

Ocado’s tech business shows ‘huge potential’

Ocado’s non-retail operations, Technology Solutions, are a key driver of the group’s valuation, but come at the cost of substantial investment.

The unit helps other retailers with their online offerings and provides its robotic warehouse technology to companies around the world. Analysts are closely monitoring the flow of new contracts.

Ocado’s latest management outlook guide for Tech Solutions pointed to 11 new call centers over the next three years, missing the City’s forecast of 12 or more, as the unit lost money again in 2023.

Susannah Streeter, head of money and markets at Hargreaves Lansdown, said: ‘Deals are also not being signed as quickly as investors had hoped for its future growth engine, Solutions.

“There is still a lot of potential here, but the growth timelines look more questionable and that has hit the valuation.”

M&S dispute looms over Ocado shares

Ocado has also angered some shareholders by handing its chief executive and co-founder, Tim Steiner, a compensation package worth up to £14.8 million.

Almost 20 per cent of investors voted against the plan at the group’s annual general meeting last month, following opposition from proxy adviser Glass Lewis and campaign organization ShareAction.

Under the terms of the plan, the former Goldman Sachs bond trader would earn a bonus of up to 1,800 per cent of his base salary if the stock reached £29.69 within three years and certain performance measures were achieved.

If this share price is not met, he could still earn around £5m on top of his base salary if other performance and return targets for investors are met.

Failure to meet targets is at the center of a payments dispute with Marks & Spencer, further undermining confidence in the Hatfield-based company.

When M&S bought a 50 per cent stake in Ocado’s UK retail operations in 2019, it gave the company £560m up front and promised to pay another £190.7m if it hit specific targets based on in performance.

In its full-year results, Ocado acknowledged that the joint venture did not meet the targets required to automatically receive the final payment.

Accounting rules estimate the payout should total just £28 million, a figure Steiner described as “ridiculously low”.

Ocado has threatened M&S with legal action, claiming that the partnership agreement allowed targets to be adjusted based on certain management decisions and actions taken during the Covid-19 pandemic.

Lawson-Johns says the row had been an “unwelcome distraction” for Ocado, given shareholders’ impatience with the business.

After reaching a high of 2,914 pence in September 2020, ocado actions They have since fallen to just 404p as the retailer racked up huge losses.

“Usually when a stock drops almost 90 percent in almost four years, it’s for a good reason,” says Sam North, market analyst at trading platform eToro.

Acquisition speculation keeps investors interested

The decline has led many to believe that the company is a possible acquisition target; Amazon was reportedly considering a bid last summer as part of its efforts to expand its grocery division in the United Kingdom.

However, the retail giant denied it had been eyeing Ocado and many investors wondered who would want to buy the business due to its cash flow problems.

There is a renewed flurry of acquisition activity involving London-listed companies, which are perceived as undervalued relative to their global peers.

If a suitor decides to approach Ocado, this will come as a small blow to the many short sellers who have correctly predicted the decline in the group’s share price, but will benefit those who recently bought the company’s shares.

North says: ‘Any decent bullish move would generate significant returns for those looking to buy now. For example, if someone bought today and the stock traded to the July 2023 highs, they would get a return of almost 200 percent.

‘Is that enough to tempt people? Perhaps, but even then, I imagine it would be a very small allocation of your capital to avoid the potential value trap.’