Ocado (LSE: OCDO) was the pandemic darling of the UK: now trading at around 740p, the shares once peaked at a high of 2,800p.
At first, the return of in-store shopping and rising inflation significantly hurt the stock. But then, as a tech company with negative cash flows, rapidly rising interest rates pushed investors towards safer assets and made the stock less attractive.
A unique player
Ocado is a unique company in the grocery business. It uses automation to beat traditional stores in online groceries, saving five times the labour that traditional grocery stores need to fulfil online orders.
Moreover, with experience running its own online grocery stores, it’s able to offer end-to-end solutions for automating online groceries for stores around the world.
Technology solutions can carry this stock
One of the most optimistic parts of its business is its technology solutions segment, which sells software and hardware (known as CFCs, customer fulfilment centres) to grocery stores around the world to improve their online grocery efficiency. As consumers’ pockets tighten, grocery stores have an even bigger incentive to streamline their operations, which led technology solutions to grow at an astounding 59% year on year (YoY).
Its offerings are also effective. Retailers like Kroger saw a 25% increase in units picked per labour hours, explaining why Kroger continues to implement Ocado’s products in more of its stores.
Finally, its customers are very sticky, as recurring fees increased by 61% YoY. This makes sense because not only does Ocado save companies money, it’s also hard to switch away once stores build out Ocado’s hardware.
While this segment only comprises 11% of total revenue, with a lot more CFCs to come and management forecasting 40% growth in revenue, it’s no surprise that investors are so optimistic.
Worrying financials
Ocado’s major weakness is its financials. Net losses have continued to widen year over year due to inflation. Its grocery business has been hit the hardest, as EBITDA declined from £31.3m in 1H 2022 to a £2.5m loss in 1H 2023. On the positive side, Ocado has been able to marginally improve its market share and management is expecting slightly positive EBITDA in retail next year.
In addition, its capital expenditures continue to be high because of investments in its technology solutions segment, increasing 18.9%. As interest rates continue to rise and macro conditions remain uncertain, the lack of profitability not only worsens investor sentiment but makes the stock highly volatile.
Valuation
Looking at its price-to-sales (P/S) ratio, it’s trading at a mere 2.74x – just slightly higher than its five-year low of 1.01x. Though it seems like it’s trading at a steep discount, the company is also transitioning from a phase of rapid growth to pivot to technology solutions as the macro conditions sour for its online grocery business. As a result, the stock seems cheap because investors are uncertain about its future.
Should I buy it?
Ocado is at a critical point in its business where a successful expansion in technology solutions could significantly grow revenue and earnings for years to come. At the same time, the macroeconomic environment — especially the projected 2024 UK recession — is hurting Ocado at its core of online groceries. Taking everything into account, I’m not going to be taking a gamble on Ocado until we have a more accurate picture of the economy or if the stock becomes oversold.
