It is hard to remember that Ocado (LSE: OCDO) was once seen as a bright new thing on the London stock market. The company has racked up massive losses over the years. Ocado shares have lost over 90% of their value in just five years.
Is there any hope left – and could this be a turnaround case for me to consider?
A decent business tacked onto an unproven business
I do think Ocado as a company has some value. However, its current structure partly obscures that.
Ocado is really two connected but different businesses in one.
The first is an online UK grocer. That is a competitive market with low profit margins. But it can still be profitable.
Indeed, in the first half of this year, the retail joint venture in which Ocado participates reported positive EBITDA (earnings before interest tax, depreciation and amortisation) of £33m.
Now, that measure excludes multiple real-life expenses and, in the final analysis, Ocado’s share of the joint venture produced a £9m loss after tax.
That is not a profit. But it is better than in the prior year period. Over time, I believe the joint venture could break into the black, thanks to growing scale. First half revenues reported 16% growth compared to the prior year period.
Ocado’s second business uses what it has learned flogging groceries to provide digital commerce solutions to other retailers. That includes technology but also things like warehousing.
This business is the main reason Ocado shares have tumbled 91% in five years, as I see it.
Alarm bells are ringing
There are quite a few problems with this business, to my mind as a potential investor.
One is that it continues to burn cash. For years, the heavy upfront spending needed to roll out the business and scale it has made this part of the business heavily loss-making.
A second problem is that the business model remains unproven. Ocado has not yet demonstrated that the solutions it provides to retailers can help it turn a profit consistently. I am not convinced it ever will.
The third problem was the bombshell announcement earlier this year that US grocer Kroger was reviewing its use of Ocado’s solutions.
Kroger remains a customer and is compensating Ocado financially for closing some facilities. But the message has gone down like a lead balloon in the City, with Ocado shares more than halving in value since August.
A possible bargain?
Is there any hope left for Ocado shares?
I think there could be. The retail operation has legs and could potentially turn out to be solidly profitable over the long run, I reckon.
Meanwhile, the technology and solutions part of the business could go either way as I see it.
In a worse-case scenario, Kroger may be just the first among other clients to scale back or abandon their involvement, making it even harder for the business to stop spilling red ink.
But a positive case could be that Kroger’s evolving use of Ocado’s offering helps the British company optimise its offering, making it more attractive to clients in future.
If things go well, today’s Ocado share price may yet look like a bargain. The risks are too large for my comfort, though, so I will not be buying any Ocado shares.
