Why are so many hedge funds betting against Ocado shares?

Investors have stepped up their bets against Ocado as the online grocer struggles to turn a profit and speculation continues over the company’s future.

It comes at a time when Ocado is 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 stock behind oilfield services group Petrofac, with 8 percent of the company’s shares held by investors betting on 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.

The Ocado Retail joint venture continues to underperform

Healthy profits remain elusive for Ocado, which reported a £394m loss for the 12 months ended December and a £581m loss the year before, despite sales continuing to rise.

The majority of the issuance is with the Marks & Spencer joint venture, Ocado Retail. Making internet supermarkets profitable has always been difficult due to the enormous infrastructure and logistics costs associated with setting up a sizable business.

Many of these costs are related to the ‘last mile’ problem: the expensive, inefficient and time-consuming delivery of goods from the warehouse to households.

Ocado has also suffered a slowdown since the end of lockdown measures, which had provided a huge boost to the online shopping sector, and its share of the UK grocery market remains low at just 1.8 percent.

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

Operating margin has plummeted by an average of -77.8 percent annually over the past five years.

Analysts wonder whether Ocado will ever make a profit again, as it has made just three (before taxes) since it was founded in 2000.

Guy Lawson-Johns, equity analyst at Hargreaves Lansdown, said: ‘Ocado has a great product, but continued uncertainty over when it will become profitable is fueling expectations that its valuation will fall further.’

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

Ocado’s tech business shows ‘great potential’

Ocado’s non-retail business, Technology Solutions, is a key driver of the group’s valuation, but comes at the cost of substantial investment.

The unit helps other retailers with their online offerings and supplies robotic warehouse technology to companies around the world. Analysts are keeping a close eye on the new contract flow.

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

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

“There is still great potential here, but the timelines for growth look more questionable, and that has distorted the valuation.”

M&S row surrounds Ocado shares

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

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

Under the terms of the plan, the former Goldman Sachs bond trader would receive a bonus worth up to 1,800 percent of his basic salary if the shares reached £29.69 in three years and certain performance measures were met.

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

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

When M&S bought a 50 percent stake in Ocado’s UK retail business in 2019, it gave the company £560 million upfront and promised to pay a further £190.7 million if it achieved specific performance targets.

In its annual results, Ocado acknowledged that the joint venture had not achieved the targets required to automatically receive the final payment.

Accounting rules estimate the payment should be just £28m, a figure Steiner described as ‘ridiculously low’.

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

Lawson-Johns said the battle was an “unwelcome distraction” for Ocado given shareholder impatience with the company.

After peaking at 2,914 pence in September 2020, Ocado shares have since fallen to just 404p as the retailer has suffered huge losses.

“When a stock is down almost 90 percent in almost four years, it’s usually for a pretty good reason,” says Sam North, market analyst at trading platform eToro.

Takeover speculation keeps investors interested

This plunge has led many to believe that the company is a potential takeover target; Amazon was reportedly considering a bid last summer as part of efforts to expand its UK supermarket business.

However, the retail giant denied it was monitoring Ocado and many investors wondered who would want to buy the company due to its cash flow problems.

There has been a renewed wave of takeover activity involving London-listed companies, which are considered undervalued compared to their global peers.

If a suitor decides to approach Ocado, it will deal a small blow to the many short sellers who have done so well in predicting the group’s share price fall, but benefit those who have recently bought the company’s shares.

North says: ‘Any decent increase would lead to significant returns for those looking to buy now. For example, if someone were to buy today and the stock traded back to the July 2023 highs, that would be a return of almost 200 percent.

‘Is that enough to seduce people? Maybe, but even then I imagine it would be a very small allocation of their capital to avoid the potential value trap.”