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Should I pile into Ocado Group plc, up 25% today?

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Shares of online grocery retailer Ocado Group (LSE: OCDO) jumped in early trading this morning, at one point advancing well north of the 25% mentioned in the headline. As I write, the stock has eased back a little, but there’s excitement in the air.

A deal in France

The catalyst for the move is today’s announcement of an agreement signed with Groupe Casino — the French mass-market retailer with operations around the world — to develop Ocado’s smart platform in France. Ocado will provide Casino with its software platform and support services along with plans that include the construction of a state-of-the-art automated warehouse using mechanical handling equipment and robots to serve the Greater Paris area, Normandie and Hauts de France regions. This looks set to take at least two years to build and launch.

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The deal could create long-term value, but the directors say earnings will remain neutral during 2018 as the costs of establishing the partnership will offset the initial fee income generated. The firm expects to invest around £15m in additional capital expenditure (capex) during 2018 to support the partnership and develop the platform, with further capex in future years. There should be growing profits during 2019 as fees from the transaction increase.

Casino will pay Ocado upfront fees on signing, then ongoing fees during the development phase. After that, fees will be linked to its use of the capacity of the warehouse centre and to certain service criteria. If things work out well, the new partners have pledged to consider the development of more centres close to other large urban areas, suggesting that today’s move could open up a new path to growth for Ocado.

More to come?

Chief executive Tim Steiner explained that the company’s scalable, modular end-to-end solutions will allow retailers such as Casino to build their online grocery offer in a profitable and sustainable way. He expects this deal to be “one of many successful collaborations with leading retailers” around the world. I reckon the fact that other retailers want to use Ocado’s system adds weight to the directors’ long-standing claims that the firm has a technological advantage that will enable it to grow and dominate the online grocery market.

There’s no shortage of investors seeing the potential in Ocado. Today’s share price around 310p throws up a forward price-to-earnings ratio for the current year around 365. With a nosebleed valuation like that, you’ve got to be very confident that revenue growth will lead to escalating earnings going forward. The problem is that earnings have failed to increase in any meaningful way so far. Maybe that’s all about to change.

Indeed, this deal could end up unlocking Ocado’s growth potential in a way that leads to profits supporting the business model. In one move, the firm gains exposure to a large chunk of the French market and has a chance to develop and roll out a new approach to capturing market share around the world. The company has a reputation for being one of the most-shorted on the London stock market, but the shorters won’t be happy today. Meanwhile, I’ll continue to watch from the sidelines.

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

 

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