The Ocado share price has rocketed…is it worth buying now?

The Ocado share price is hard to justify. I’d sooner invest in something a bit cheaper and less speculative, writes Thomas Carr.

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The Ocado (LSE: OCDO) share price has rocketed of late, up more than 50% since the start of the year. But for Ocado this is nothing new, the share price has risen four-fold in just three years. It reflects the group’s transition away from being a simple online grocery business, to a technology and data-driven provider of automation solutions to the world’s biggest grocery retailers.

Ocado’s technologies provide grocery retailers with a platform that brings together the different aspects of e-commerce. At the heart of this are its warehouse management systems, with automation technology that involves robots moving about on a grid-like system, picking up items ready for dispatch. Ocado reckons it’s the most advanced warehouse automation system for grocery in the world. Its platform also provides predictive analytics to help forecast demand and plan inventory levels, as well as integrated delivery systems.

Online retail growing

These technologies have been developed and tested on Ocado’s own retail division, what is now an online joint venture with Marks & Spencer. The JV now has a 14% share of the UK online grocery market and has grown significantly during lockdown. Second-quarter sales rose by 40% compared to the same period last year as consumers rushed to stock up on long-life foods. In fact, Ocado reckons that the online share of the UK grocery market has doubled over the last few months, to around 13%. What’s more, management think much of that change is permanent.

Top-line results are impressive. Annual revenues for the group have grown by an average of 11% for the last four years. A trend that looks set to continue. But the bottom line is atrocious. Ocado sank to a net loss of £221m last year, and doesn’t look like it’s going to break even any time soon.

Ocado’s retail division accounted for over 90% of total group sales last year. Retail operating margins of just 1.3% mean that the bulk of the company contributes little to profits. Instead, the Ocado share price is completely reliant on how well its technology solutions division performs. These solutions have so far been sold to nine clients (one of which is Ocado Retail). Management has estimated the total fee opportunity to be at least £3.5bn.

Would I buy into the Ocado share price?

With a market capitalisation of over £14bn and ballooning losses, I think the Ocado share price is pretty much pricing-in perfection. Based on its current earnings and book value, I don’t think it’s worth more than a billion pounds. But Ocado’s share price is based on what investors think it will be worth in the future. If everything goes right, then Ocado could become the UK’s Amazon. The group is already planning to pivot into other industries. But for every Amazon, there are thousands of smaller companies that don’t make it.

For me, there are considerable downside risks. Anything other than perfect execution of its strategy and there’s only one way this share is going. I’d much prefer to invest in something stable and predictable. Sticking with grocery, Morrisons shares are a fraction of the cost. Its market capitalisation is just £4.5bn, but with that you get £348m in net profit and a book value of £4.5bn. To me it’s a no-brainer.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Thomas 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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