Should I buy this tumbling UK tech stock?

After a 44% fall in this UK tech stock price over the past year, our writer considers whether now is a buying opportunity for his portfolio.

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Many investors like tech shares for their potential growth prospects. But one UK tech stock has seen its price crumble lately. Over the past year, the shares have fallen 44%, as of the price at the time of writing this article today. Yesterday they hit a new 12-month low.

Below I consider whether that offers a buying opportunity for my portfolio.

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UK tech stock — or retailer?

The company in question is Ocado (LSE: OCDO). A lot of people may think of this as a retailer not a tech business.

But Ocado’s retail operation is only one part of its business model. The company has used its experience to build an online commerce model offering everything from customer interfaces to automated warehouses. It hopes to sell this service to other retailers. The company has already signed up large shop chains, including Morrisons and Kroger.

I think it is this tech element of the Ocado business model that excited investors in recent years. The loss-making company has a market capitalisation of £11bn. I do not think that is justified by the highly competitive, low-margin business in which its retail arm operates. Tesco has a market cap only twice as big at £22bn. But Tesco’s most recent quarterly retail revenue was £20.1bn, compared to just £0.5bn at Ocado.

Instead of focusing on its retail operation, I think investors have been seeing Ocado as a potential online commerce solution provider, like Shopify or the solutions-providing part of Amazon.

Capital-intensive growth strategy

Like Shopify, Ocado’s digital technology may be scalable. In theory that could lead to improving profitability once it reaches critical mass. But key parts of its business look less scalable to me. To serve a client like Kroger, for example, the company typically builds new fulfilment centres. That involves substantial capital expenditure. I do not see it as scalable in the way a digital footprint can be. Once a warehouse operates at capacity, that is it. To increase fulfilment, it needs to spend money on more warehousing space. That is far more complex than simply adding extra computing power in the cloud at a marginal cost.

Ocado’s capital expenditure concerns me as it reduces the likelihood of profits in coming years. In its last annual results, the company recorded £526m of capital expenditure. It forecast capex of £700m for the most recent full year, the results for which are due next month.

Will I buy?

Spending money to grow is common business practice. Indeed, a positive investment case for Ocado could suggest that this ongoing expenditure is creating a world-class digital commerce service. That could enable the company to charge a price premium. As capex falls once the infrastructure is in place, the price premium could lead to attractive profits.

But what concerns me about Ocado’s business model is that it is spending large sums year after year, while profitability remains elusive. Amazon is only six years older. But last year its business model enabled £15.7bn of net income, while Ocado again made a loss.

I think the crumbling Ocado share price reflects growing investor concern about the company’s continued capex needs and weak profit outlook. I expect that to continue and think the price could fall further. I will not be buying Ocado for my portfolio.

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Christopher Ruane has no position in any of the shares mentioned. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK has recommended Amazon, Ocado Group, Shopify, and Tesco. 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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